It Doesn’t Feel Like a Bull Market - Weekly Blog # 866

 

 

Mike Lipper’s Monday Morning Musings

 

It Doesn’t Feel Like a Bull Market

 

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

 

 

 

 

If not Convincingly Up, Maybe Down

With most US stock price indexes near their all-time peaks in the latest week, why are only 37% of stocks in the S&P 500 rising? Forty-six percent of the stocks on the NASDAQ market rose during this period. (The NASDAQ market has more speculative stocks, like technology and smaller financials.  While not strictly comparable, NASDAQ volume has risen +15% year over year, while NYSE volume contracted -19%.)

 

Warning Light

Could it be that investors are sensing a coming decline. Looking at other data series, the US dollar may have peaked. The more economically sensitive Dow Jones Transportation Index has also completed two-thirds of a typical reversal chart pattern.

 

Too Much of a Good Thing

Another flashing warning light is the enormous amount of money made over the last 10 years. (Using total return data on mutual funds and index funds, the following categories have doubled their pretax money in the 10-years through last Thursday: Large Growth, Large Value, Small Cap Growth, Small Cap Value, S&P 500, and S&P 400. The range for these averages was between 2.35X and 2.01X. I have added Financial Services funds which gained 3.57X). I believe that in addition to portfolio earnings growing, there has been multiple expansion. P/E Ratios can move up and down faster than earnings. It is this concern that leaves some of us worried.

 

Others Are Worried

The Depression, which many economists believe started in 1933, actually started at least 5 years earlier in the farmland. Agricultural prices were dropping due to imports, which eventually led to the US putting up a tariff wall. Currently, the farming community, their suppliers, and financial supporters are worried. Some in the farming community expect income to drop 25% in 2025.

 

The stock market would be wise to pay attention to high-quality US bonds, whose yields have risen +116 basis points over the last year compared to a rise of +44 basis points for middle quality bond yields.  (Yields up bond prices down.)

 

Stock market investors who know their history should likewise be concerned about farm prices. Historically, the sharpest analysts following these trends come from the 4 major agricultural trading houses. One of these is Cargill, who has just announced plans to lay off 5% of its workforce. A glance at the 2024 electoral college map reveals the red team dominating the middle of the country. A similar situation forced a Presidential change in 1932, which some believe was a contributor to WWII.

 

Have we Entered a New Market Cycle?

Do many people recognize a change underway early in the long march to a different environment? I believe a change may be underway, but I don’t know where we are going.

 

I recognize that beneath the surface the two major engines driving the world are the USA and China. Both are not as healthy as they portray, with productivity doing poorly when adjusted for inflation. One example is the US significantly leading the world in medical spending, while life expectancy trails behind Japan, France, Canada, and Germany.

 

We are not Allowed to Think Creatively

For the most part our governance and educational systems are highly regimented to reproduce exactly what was or is. This has been difficult for me to recognize. Consider the amount of mathematical thinking in this blog, which comes from being taught to learn from the text or copying from the past.

 

Our systems are designed to produce copycats, or at least controllable members. We do not try very hard to generate creativity. In college we were taught what worked in the past. I only had one critical exam in all things management accounting, where 50% of the final test was “What’s wrong with Accounting?”. This caused me to recognize that GAAP accounting is designed to avoid lawsuits, not to help make investment decisions. These lawsuits might be brought against investment bankers and various marketers. The closest I got to seeing this was during a Security Analysis course with the famed Professor David Dodd of the famed Graham and Dodd, but only during one portion of the course. The lesson was a real eye-opener when we turned to valuing a company in bankruptcy. The first thing we were instructed to do was reconstruct the GAAP accounting by valuing what was salable and at what price. Only a portion of the inventory could be sold, and it was valued after disposal cost. Buildings and land could be valued up or down, depending on use. Finally, there was the cost of shutting down, including appropriately taking care of the employees.

 

I never learned to be a DaVinci, but I came close by watching what Steve Jobs at Apple did. (Even though I currently own the stock, I do not recommend ownership, except for very narrow purposes.) What Jobs created and Tim Cook built and marketed brilliantly was creating new uses for existing technology. I suspect much of what Jobs created came from his studies of Asian religions. Today, it is interesting to see a surprising amount of creativity coming from foreign-born people working for US corporations or investment capital.

 

Question: What have you done creatively?  

 

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Mike Lipper's Blog: Reading the Future from History - Weekly Blog # 863

 

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BIGGER RISKS THAN THE ELECTION - Weekly Blog # 653

 

Mike Lipper’s Monday Morning Musings

BIGGER RISKS THAN THE ELECTION

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

Risks should often be measured against the inverse of expectations. As our regular readers know, since the beginning of September I have warned that the stock markets have entered an emotional period where long-term investments should not be made. This is the last weekend before election day, but it is probably still at least two weeks or more before both the Electoral College and the makeup of both Houses of Congress are determined. Whatever the preliminary results, there is still a good chance of a “relief rally”. Based on past history, an extreme rally would trigger a reversal, as those politically invested in the losers reduce their exposure and prepare to sit out the next phase in a bunker, betting the winners won’t be able to deliver and will have only a short lease on the levers of power.

The Bigger Risks

I am concerned for those who address their multiple long-term investment challenges less emotionally. As an analyst and investor I am always more concerned with unexpected risks, rather than those trumped by the pundits which have already being discounted. I am also focused on material changes that impact supply and demand momentum. From this predicate I see two very different unfocused risks for most investors, the first an economic risk and the second a market risk.

Prudent Business Managers Could Have Been Wrong

Many businesspeople believe that their single most precious asset is the trust of their repeat customers, generated by the people who interact with them at the firm. I believe that all the people I’ve worked with were there to service our clients, whatever role they played. When periodic, cyclical, financial problems arose, I looked where we could try harder. However, there were times when the market was saying our costs were too high for our current volume of business. Like other businesspeople I looked again and again at where I could cut. First on the list was my compensation and last on the list was the compensation and jobs of my associates. I believe that most privately owned service-oriented businesses hold the same view. CEOs of publicly traded corporations by comparison often feel their first duty is to protect their company’s financial condition. Thus, during this pandemic and it’s period of lockdowns, publicly traded companies laid off or furloughed a higher percentage of their labor force in the early months than did private companies.

Now some deceptive good news, the level of business is recovering. Evidenced by brief quotes about factory orders from of regional Federal Reserve Banks in October:

• Philadelphia - Highest level since 1973
• Dallas -Two-year high
• Kansas City - Matches strongest since May 2018
• Richmond - Best since November 2017

While these are encouraging comments, notice how the good times appear to be coming back to the now politically favored manufacturing component of our economy. My concern is that service businesses account for over 60% of US economic activity and consequently the largest part of the workforce. I am concerned for these people who in many cases have not been able to substantially recover due to the lockdowns of their businesses. Many of the owners of these businesses were slow to cut back on the critical people that made their businesses prosper. The owners carried their people on the backs of supplied capital, some of which was borrowed or tapped from other sources of equity. For sound political and other reasons, banks have carried these loans to privately-owned, service businesses. Banks can do this because they are stuffed with too many cash deposits. (While other short-term interest rates are rising, rates paid on money market deposit accounts have continued to drop to their current average of 0.19%.)

A stimulus bill might help temporarily, but it is not a long-term solution, particularly if the retail sector is largely locked down. I have two concerns, the first being immediate cash needs. The second concern is more fundamental. Walking down many Main streets (like High Street in Britain), current shop owners cannot get their children interested in taking on the burdens of ownership. In a world of increased automation replacing expensive human labor, we cannot afford a shrinking service sector. This is not a short-term consideration.

Broad Scale Large Leverage is Dangerous

Since the beginning of transferrable money, people have been borrowing and lending with some borrowers unable to repay their debts on time. Due to low returns from banks and to some degree in their minds an insufficient rate of return on organized stock markets, individuals and institutions have turned to various credit instruments and arrangements. The current pandemic/lockdown has made it clear that most interest rates do not have sufficient room for repayment concerns. Despite this, I expect credit will rise to a dangerous point.

To keep their economies and the price of debt under control, governments and their central banks will be the first feeders of capital, although government generated money is currently not being fully absorbed by job producing uses and the excess is building. Low interest rates are currently not considered attractive enough for many in the securities markets, so they are looking to the credit markets. In effect these investors are supplying leverage to companies and individuals without sufficient concerns for defaults. 

One particular concern of mine was announced by the SEC this week, ETFs will now be able to borrow twice the amount of capital, instead of the 100% of equity capital currently available. Undoubtedly, some funds using this new facility will produce great results for some time, but not all the time. A single margin-call on an ETF could be the tinder that starts a major decline. Perhaps it’s coincidental, but this week only six of seventy-two prices tracked by The Wall Street Journal rose. These prices include stock indices, currencies, commodities, and ETFs. Also, in the week ended Thursday, the average of 7,314 US Diversified Equity Funds fell –4.16%, bringing the year-to-date gain to +1.00%. Remember, markets fall at three times the speed of rising markets, due to margin calls.

Working Conclusion: 

Sound investments should be held for the long-term. This may not be the time to find bargains.  

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

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

https://mikelipper.blogspot.com/2020/10/momentum-is-slowing-under-too-many.html

https://mikelipper.blogspot.com/2020/10/mike-lippers-monday-morning-musings-are.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.