Dangers “Smart Money” & Thin Markets - Weekly Blog # 816

 

Mike Lipper’s Monday Morning Musings

Dangers “Smart Money” & Thin Markets

 

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

 

 

 

Christmas Breaks & Wishes

Like most weekly blog producers, I experienced an early December dilemma. Should I send out my seasonal best wishes to our readers and not produce the final December blog, or write it as usual? Not writing the blog was very tempting, but I then remembered George Washington’s very first military success in New Jersey. He and relatively small number of Patriots crossed the Delaware River and attacked the British (German Hessians) on Christmas Morning at Princeton.

 

My fear of a similar attack on our securities markets led to my decision to publish the blog. But to all our readers, I extend a very deep and heartfelt “Merry Christmas & Happy Holidays”

 

What Could Go Wrong?

1. I hope nothing.
2. The late December equity markets produced relatively light volume.
3. Below is a racetrack lesson on a not particularly distinguished bunch of horses registered for an unimportant race.

Late in the betting period there is a sudden surge in betting on a specific horse for no apparent reason. The chatter in the grandstand is that it was caused by external bookmakers balancing their betting exposure on a given horse. The presumption being that the clients of the bookmakers “knew” something that improved its probabilities. This surge was labeled “smart money” by those at the track. Sometimes, but not always, the chosen bet wins.

 

My fear is what market analysts call the distribution effect, because they understand what a third Obama White House doesn’t. That the initial absorber of sudden volume often tries to immediately offload as much of its liquidity volume on other players as possible. This secondary distribution can be repeated numerous times, enlarging the impact.

 

As happened during the last 2 hours on Wednesday, where all the major US stock indices fell significantly. Some observers pointed to a large trade, a series of large trades of a highly leveraged short-term derivative. By the end of the day individual securities were down multiple percentage points. Early Asian markets fell, but by the end of the trading day losses were small. On Thursday stocks rallied almost back to Wednesday’s opening and on Friday there was a slight gain.

 

This attack, like the one on the “British forces” at Princeton, did not have a material impact on the war other than to buoy up Washington’s spirits and please the Congress in Philadelphia.

 

I have no idea whether there will be other “smart money” surprises during the remainder of the year, but at least I am prepared.

 

Other Inputs Could Be Important

1. 58% of US households owned stocks in last 3 years, up from 53% previously. This included 21% from direct owners, up from 15% previously. (At some point this could have political implications). Only Estonia has a greater commitment to stocks.
2. All 3 major stock indices still have November price gaps.
3. Bankruptcies have risen to over 30% in the US and to over 25% in Germany.
4. Global deal flow is at a decade low.
5. PJIM forecasts sluggish growth for the next couple years.
6. FEDEX margins were materially down on a slight sales drop.
7. Many Wall Street bonuses were flat or up marginally.
8. The White House is considering an increase in Chinese tariffs, another pro-inflation move.
9. China announced new wide-ranging rules to reduce the number of on-line gaming hours. Not only did this wipe out $80 Billion in market value from the two largest Chinese game providers, but it also impacted other Chinese stocks and numerous stocks in other markets.
10. A picture is often worth more than a thousand words. The drawing room where the US President meets foreign leaders has 5 portraits of former presidents. The largest portrait is of FDR centered among the others. He appears crucial to the current President’s thinking. The similarities are pro-inflation, weak fighting forces, anti-business rules, higher taxes on the most productive, and isolationist policies. All of which turned a recession into a depression and encouraged our enemies. 

 

 

 

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Mike Lipper's Blog: Searching For Answers - Weekly Blog # 815

Mike Lipper's Blog: Reactions from a Contrarian - Weekly Blog # 814

Mike Lipper's Blog: 3 Senior Lessons + Upsetting Parallel - Weekly Blog # 813

 

 

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Stock Markets Move on Expectations - Weekly Blog # 805

 

Mike Lipper’s Monday Morning Musings

Stock Markets Move on Expectations

Commodities Move on Transactions

Most Economics Relate to Needs

Politics Rotate on Vote Guesses

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

 

Variables

These are among the more significant variables that investors and the rest of society juggle in reaching investment decisions. Most investors focus their attention on only a few variables. Some use just one, like price charts or reported earnings.

 

Perhaps my lack of confidence in understanding the complete details of variables drives me to look for correlations, which is why I ponder many variables. This tends to result in the creation of diversified portfolios of funds and individual securities. Because my clients and I invest to meet a number of different needs, our investments are focused on several time periods.

 

With these thoughts as guidelines, I’ll share a number of factors I am concerned about that leave me worried. I expect the future to include numerous changes, with some coming as surprises. My portfolios are likely to be fully invested, with a willingness to shift elements when I become more convinced of the wisdom of future actions.

 

The tragedy in Israel is too new to take into proper perspective. Thus, I am excluding it from this blog, but not from my mind.

 

List of Worries (Not in rank order)

1. The number of small company bankruptcies is rising, along with general error rates. These are some of the critical connecting points in our society and likely to have larger repercussions.
2. The drop in food consumption at low-end retail outlets suggests budgets are getting stretched.
3. Jaime Dimon’s 100-year prediction of a 3 ½ day work week leaves too much time for troublemaking.
4. Those with advanced degrees have lost confidence in colleges/universities. Students graduating with degrees, including PhDs, have no job opportunities for their degrees. (All the nobility were blamed, and many executed during the French Revolution.)
5. A little more than half of mutual fund peer-group averages have generated losses over the last 3 years. (There is a risk of people refusing to invest.)
6. As developing nations mature, they attempt to import replacement of some of their imports, which reduces world trade.
7. UPS and FedEx often sell at discounts. (Deflation)
8. 75% of the items listed in the WSJ weekend prices declined (Deflation)
9. The S&P Goldman Sachs Commodity Index rose +4% in September. Due to dollar strength, Energy and Metals rose +3.5%, with Agriculture falling -4.35%. There may be some speculative input in these numbers.

 

Critical Questions:

1. What are the indicators you are watching?
2. What do you think?
3. Will you share your thoughts?                                                                          

 

 

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Mike Lipper's Blog: Prepare to be Bullish, Long-Term - Weekly Blog # 804

Mike Lipper's Blog: Selling: Art & Risks, Current & Later - Weekly Blog # 803

Mike Lipper's Blog: Investment Thinking During a Lull - Weekly Blog # 802

 

 

 

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Planning for Rising Stock Prices - Weekly Blog # 751

 

 

 

Mike Lipper’s Monday Morning Musings

 

Planning for Rising Stock Prices

 

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

    

 

 

Contrarian Concerns

If only we could be unbiased when observing stock markets and investors. We might get clued into probable future steps we should take. We should examine all that is exposed to us. The strengths and weaknesses of realities, rumors, and reactions. In many cases crowds believe in "facts", which when fulfilled provide comfort. In much the same way contrarians often see the opposite in the same set of facts.

 

For an extended period, I have been seeing growing evidence of problems for various stock markets and related countries. I was comfortable with these feelings because relatively few perceptive analysts and other investors shared them.

 

Now, the worst of all possible trends is befalling a contrarian. The attitude of many sophisticated stock market investors is turning, echoing the attitude of the US Treasury bond market. Worse still, leaders in the commercial world are dealing with a present and likely future collapse of demand for their products and services.

 

International Paper, Packaging Corp, and West Rock (*) announced a massive inventory glut of containerboard, which is critical in packaging most shipped goods. Consequently, I was not surprised by FedEx's quarterly earnings announcement, which fell 32 % below analysts’ estimates. The release indicated the company was reducing usage of its plane fleet, closing offices, and cutting expenses.

 

When operating companies have these problems it almost always means smaller M&A activity and underwriting. Thus, it is not a surprise that canny Goldman Sachs (*) reintroduced a policy laying-off the bottom performers of its talented staff. This week's IPO actions by American International Group (*) have them selling some Corebridge Financial at the low end of the expected price range, which fell below the issue price in the after-market.

 

(*) Held in personal accounts

 

My reaction to this negative news was to accelerate my previously mentioned plans to look for new buying opportunities in new names.

 

An Organized Search Process

I have had discussions with sophisticated investors who have exited the equity market with 30% or more of their prior commitment. This has created a potential 30% buying reserve.

 

As subscribers to this blog know, I question whether we have seen the bottom of the US stock market decline. The S&P 500 hit its technical price low since June at roughly 3900 this week. One respected market analyst’s response was that the index had bent but did not break.

 

I don't know if the September or June bottom will hold or break at the 3600 or 3000 level. Although it is possible we have seen a bottom from which an upward expansion could take place.

 

My tactic in this case is to dollar cost average into favored investments. I divide my purchasing reserve by 6, putting 5% into the purchase bucket. One reason I believe we are likely to go into a serious recession or worse is that I see too many imbalances, with declining efficiency and productivity in the economy. Although I could be wrong. The way I deal with it is to invest differently than what produced my existing portfolio. So, if the market is flat at the end of the reinvestment period, I would have 70% in the original holdings and 30% in new thinking.

 

The first hurdle is determining the frequency of investing is the reinvestment money. One could choose monthly, quarterly, or yearly. That decision should pivot on the kind of decline expected. It could simply be a price decline where monthly investing generates a good result. If you think the market went down primarily because of imbalances in the economy, then investing quarterly makes sense, as these problems won't be solved until next year at the earliest. Although the market should anticipate this event somewhat. An annual investment makes sense if you believe we might be entering a period of stagflation.

 

At first blush the annual investment might seem excessive. However, we experienced two periods of stagflation in the 1930s and 1970s, which suggests it could happen. Since everything these days seems to move at warp speed, I searched the mutual fund data bank produced by my old firm this week. I examined the 170 mutual fund investment objective performance groups averages through this Thursday. While most had a down calendar year, prior years were positive.

 

For the last three years 40% of the performance averages lost money. Thirteen percent lost money over five years and 5% lost money over ten years. These numbers suggest we could be in for a long dull period.

 

The reinvestment plan I am suggesting is not a hands-off procedure. Anytime the targeted investment is off 10% from the prior determined period, I would double the commitment. This may produce a bargain for the investor. It also reduces the length of the investment period. On the other hand, if the target price drops 25% I would pass on the opportunity and wait for the next period, assuming the basic research remains favorable.

 

What to Buy to Complement the Portfolio

Remember, reinvestment is meant to offset investment opportunity in existing holdings. I suspect most holdings are dollar dependent, so at some dollar level the US will price itself out to foreign buyers. Internal political issues in various countries will also improve.

 

For those that have never owned a stock traded beyond our border, I would start with some Canadian holdings.

 

India has the largest middle class in the world. Other Asian countries, including China, are a good hedge against the dollar.

 

Another approach not in many portfolios are companies developing new products and services to fill unmet needs for new products/services not currently available.

 

If the individual selection of securities takes up too much time and you lack confidence in your selection, you can use mutual funds. As these funds are intended to address other needs in an investment portfolio, the following list of attributes may be useful in the selection process:

• The portfolio manager has ten years of experience running the fund, with a record that can be researched to understand down periods.
• A focused portfolio of under 70 names in two handfuls of sectors.
• A portfolio letter released at least semi-annually that is easy to read. It should be about the portfolio and not the economy.
• A proper discussion of what didn't work and why, without blaming others for mistakes.

If all of this is too intense, I suggest index funds covering large and small companies, both here and overseas. Most index funds track a published index in terms of weighting how much to invest in each security. This is where a critical decision must be made. Most index funds own the same percentage the stock has in the index. Consequently, a handful of the biggest positions in the fund will drive performance in rising markets. While great in a rising market, it could be a negative in a declining market where investors sell their most liquid holdings. Equal weighted index funds in some cases will slightly underperform on the way up but decline less than capitalization weighted index funds on the way down.

 

Question of the week:

Are you open to investing differently for the next good market?

 

 

 

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

https://mikelipper.blogspot.com/2022/09/mike-lippers-monday-morning-musings.html

 

https://mikelipper.blogspot.com/2022/09/i-can-be-wrong-weekly-blog-749.html

 

https://mikelipper.blogspot.com/2022/08/4-5-changes-disruptions-faulty-weekly.html

 

 

 

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Copyright © 2008 - 2022

 

A. Michael Lipper, CFA

All rights reserved.

 

Contact author for limited redistribution permission.

  

Picking Winners and Avoiding Losers: Thanksgiving Lessons

A good analyst and a better investor learn from what they are exposed to in their life experiences. We are all interested in picking winners and particularly in avoiding losers. In the US on Thursday, we celebrated Thanksgiving. This official holiday is similar to other harvest holidays celebrated in many countries that have developed from an agrarian base. Within the US, the holiday is an occasion to watch traditional American football games, either in person, on a television or on a computer screen. Immediately after the holiday is the somewhat official beginning of Christmas and Chanukah shopping season both in stores and Online.

As family and friends gather, often there are opportunities to acknowledge what we are grateful for; forgiving those that have disappointed us, but not forgetting the lessons learned.

Weather impacts

In New Jersey and some parts of New York and other states, one of the things that we are thankful for is that we have begun recovering from the recent visit of the super storm Sandy. Some of us were just inconvenienced by the loss of power for a period of days into weeks. Others have lost their homes in part or in total to the combinations of the hurricane followed by a “nor’easter” snowstorm, and in some cases resultant fires. The physical, emotional and financial damage is starting to be more fully understood. Whatever the immediate size of the financial loss, by current estimate the money spent on rebuilding, and in many cases new construction, will be larger than the financial losses sustained. These expenditures on housing, infrastructure and shoreline development will occur over a couple of years, as much concerted planning is needed to avoid some of the ravages of future storms. My guess is that the infrastructure and the rebuilding spending will initially focus on an attempt to restore what was in the impacted area first. There is likely a second phase that may occur as people start to take a long-term view. Much of New York, Boston, Hong Kong, Singapore and elsewhere are built on reclaimed land from nearby oceans and rivers. There are people who believe that within the next 100-300 years these lands will be subject to waters rising five feet, which would flood LaGuardia Airport in Queens and Logan Airport in Boston for example. If these fears are acted upon, the indirect costs of Sandy will be huge.

The national media has heavily focused on the impact of Sandy and has largely ignored the weather event that will probably create a larger loss, the devastating drought that is affecting all or parts of 17 Midwest and Western states. The drought is expected to intensify through the winter. While the US is probably the most productive country in the world, there is some possibility that we will have food shortages and suffer some inflationary pressure, particularly intense on the less well-off. A related issue to the food shortage potential is the actual substantial curtailment of barge traffic along the Mississippi River. Due to government water conservation policy, the Missouri River, which is fed in part by dams, and in turn feeds the Mississippi, has not be receiving its full bountiful supply of water since last week. The barges with their deep bottoms that won’t be able to go downriver carry some $7 billion worth of commodities, coal and other products, much of which feeds US export markets. 

Two weekend analytical observations

As long time readers of my posts know, I usually comment upon my visits to a nearby high-end shopping mall during the Thanksgiving weekend. This time I visited the shopping center twice; once on so-called Black Friday and again on Sunday. In contrast to years ago, I was able to find parking spaces. On Sunday I parked where we normally park during the week, not a good sign for retail sales. One of the reasons that parking was relatively easy was that there were fewer cars with New York license plates. In the past, the difference between New York and New Jersey sales taxes drove New Yorkers to shop for more expensive items into New Jersey. (A new very large mall has recently opened that is much closer to New York City which could have attracted the tax conscious shopper.)  Walking in the mall was relatively easy with very few crowded locations; the Apple store being one. Judging by what people were carrying, there were more lookers than shoppers. Some high-end stores changed their merchandise mix toward lower price point merchandise, one being Tiffany. This tactic did not seem to attract many of the well-dressed shoppers that had taken great pains to look attractive. The price and tax conscious high-end shoppers were not enthused by what they were being offered. The two walking tours however, don’t tell us how much shopping is being done Online. I will watch whether the regular FedEx and UPS truck deliveries on our block are delayed from their normal delivery times and if they seem to be heavily laden. At this point, if I had to make a judgment, I'd say that this won’t be a great season for high-end retail shops.

The second observation is that there is much to learn from watching National Football League* games on Thanksgiving Day. I have long stated that my two great learning experiences were my active duty service in the US Marine Corps and my hours at various New York race tracks, trying to wager successfully and avoid too many losses. The study of past performance and other factors which I followed were called handicapping, which focused on how changing conditions would affect the results of future races. One of the techniques that I used in reviewing past performance was to look for consistent, hopefully improving, patterns. Many times these encouraging patterns were interrupted by inconsistent behavior. If there were only one or very few inconsistent results, I followed the approach of excluding the inconsistent results and believing that if the conditions were similar to the races where the results were consistent, to believe that the next race the horse was more likely than not to return to its trend of consistent results. Long before the leading Football teams acknowledged that they had hired statisticians as revealed in an article by Judy Battista in Sunday’s New York Times, I was applying this technique while enjoying watching various professional football games. On Thanksgiving Thursday, there were two games where this kind of analysis was useful. In the first game, a grudge match between the New York Jets and the New England Patriots, the final score of 49 (New England) to 19 (Jets) was misleading in terms of a comparison of the potential value of the teams in securing future victories. As is often the case, God is in the details. In the first quarter neither team scored. In the second half, the Jets scored 19 points vs. 14 for New England. However, in the second quarter through a series of interceptions and fumbles, New England scored 35 points, including three touchdowns in about one minute! From my handicapping viewpoint, what happened to the Jets is the equivalent of a jockey dropping his whip or a saddle slipping badly, which led me to exclude the second quarter as indicative of future performance. Applying this approach to selecting funds (and to some degree individual securities), I would be more interested at the right price (odds) backing the Jets than the Patriots. When I apply this to funds, I am willing to throw out the results of 2008, particularly if by early 2010 the fund had recovered from its 2008 loss. Thus one might say that I can be forgiving.

The second game put the Texans from Houston against the Detroit Lions. Detroit traditionally has a game on Thanksgiving Day, for in a much earlier time it could not get a local field to play on for a normal weekend game after the holiday; so a tradition began with the Lions playing this game on Thanksgiving. The Lions traditionally have a poor Win-Loss record. This year’s game was against the Texans who had the best record for the season in professional football of 9 wins and 1 loss. Remarkably at the end of regulation period, the two teams were tied at 31 points apiece and so they had to play in an overtime period. At our Thanksgiving dinner there were relatives from Michigan. The Lady of the House, who had suffered through many football games in Michigan, assured us who were watching the game that the Lions would find some way to lose, which they did. She was not forgetting the team’s past problems. In similar fashion, a fund or manager that consistently disappoints is not likely to rise up for a sustained period.

* I have the honor and privilege to work on the National Football League/Players Association defined contribution plans.

Applications for the care and feeding of investment managers

As we are all humans, we should learn to forgive them, as this is good for own mental health.  Even the “programmers” that control the inputs to quantitative funds are human, and therefore one should allow for some mistakes. The key is the duration and explanation for the shortfalls from our expectations. However, I firmly believe that performance results are not the key to future results but rather a starting point to raise our understanding as to the past, current and future conditions when a manager can produce consistent results for a while.    

Now it is your turn to share:

What are you thankful for?

For what are you willing to forgive investment professionals?

What should we forget?

_____________________________________________

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More Positives than Negatives Ahead

Using an often-repeated term of Donald Rumsfeld, the job of investors looking to their future returns could be characterized as a search for the “unknown unknowns,” (as opposed to the “known unknowns”). This is the exact task before me today. Based upon past experience, I do not believe that the future will suddenly reveal itself to me with such sufficient clarity that I can immediately place orders for individual securities or funds. Since the unknowns are truly unknown to me, I start collecting what is apparently known to me. I cast my net wide to gather bits and pieces of the current scene with the hope that, in sum, I will get useful insights into the future. The members of this blog’s audience will have to determine whether what follows is useful or insightful for them.

In terms of the real economy, the most bullish press account that I have seen is about FedEx, which has been a long term holding of the PRIMECAP fund that we own for clients. FedEx stated on the busiest shipment day of the year that its shipments were up 17% over the busiest day in the prior year. Citing this improvement, the company announced that it would resume salary increases and make contributions to its retirement plan. This comes from a company that recently reported a 30% decline in earnings. While a possible reason for the surge of shipments is a shift in the behavior of clients’ inventory management, I find the company’s wage and benefit decision to be encouraging.

I find it somewhat ironic that the Russian finance minister announced last week that the Russian recession was over. Note that the US recession has not been declared ended, though many believe it to be over. Considering mineral production and mining are much more important than financial and other service sectors in Russia, the minister’s declaration is a good sign for the global recovery. (One wonders whether Russia is becoming more of a capitalist state as the US is becoming more socialist.) A possible sour note to the global recovery is the announcement that Tokyo Steel has reduced its prices for the second time in three months. This decrease is in the face of rising Chinese spot iron ore prices. Clearly there are leads and lags to the global recovery story.

Gold is always a barometer of people’s fears and the willingness of those who will take advantage of these feelings. There are six Indian gold ETFs which had a 57% increase in the number of shareholder accounts in the six months ending September 30th, 2009. In the same period, these six ETFs saw assets rise 72%, showing some fear for the value of the Indian Rupee. Taking advantage of this increase in demand for gold at the retail level, the United Nations has recently licensed its own gold bullion coins to be minted and sold in Europe. The so-called World Government appears to be taking advantage of the inflation that is being seen in practically all of its members. Judging by how well the UN manages its own fiscal affairs, my guess is that we may well be seeing a top in the price of gold. That does not mean a near-term peak in inflation fears.

In the heart of almost every stock market bull is a Chinese noodle. Not only is China becoming the paramount buyer of many commodities (it has been reported that Chinese-built Cadillacs are outpacing those sold in the US), Chinese interests are becoming increasingly active in a number of stock and bond markets around the world. The National Social Security Fund of China intends to raise its maximum overseas investment from 7% to 20%. Within two years the fund will be at $ 146 billion. The fund’s goal is to beat inflation by producing an average annual rate of return no smaller than 3.5% in the 2008-2012 period. In the “out years,” the gain must be higher, as it lost $5.77 billion in Fiscal 2008. There are similar demands on other sovereign wealth funds who have suffered losses in 2008, and in some cases 2009. This suggests to me that in so-called high quality paper, we will see more speculation. Too early to call it the next bubble, but one we need to watch.

As the Chinese become wealthier, one should watch their consumer behavior. One interesting trend is that expectant mothers in China are traveling to Hong Kong to give birth. There are three possible reasons for this trend. Healthcare is better in Hong Kong, the purported advantage of the child having a Hong Kong passport, and/or a decision on the part of the parents to have more than one child. (Interesting how individuals react to the plans for them dictated by their government. I believe expectant mothers are part of a global medical tourism trend.) As the Chinese become more concerned about inflation there will be a sharp increase in the proportion of car purchases that will be financed, expected to rise from 8% currently to perhaps the 70% found in India, but not as high as the 85% found in the US. This is important as it will drive greater use of financial services, which eventually will be a plus to the global financial services industry.

One of the safest bets about the future is that the US financial service industries will undergo material structural changes. In a well-reasoned opinion piece in The Wall Street Journal by Robert Wilmers, the CEO of M&T Bank, the financial results of the five largest bank holding companies are contrasted with the rest of the bank holding companies. The five are Bank of America, Citigroup, JP Morgan Chase, Goldman Sachs, and Morgan Stanley.

Through the first nine months 2009, these five banks earned $30.1 billion compared to combined losses at the remaining bank holding companies. The “big five” lost $14 billion last year. The turn-around in their fortunes did not come from increasing lending, but from their trading activities. The first three banks alone had trading revenues of $26.8 billion in the nine months, having lost $41.3 billion in the year before. The two new to the bank holding status probably did even better. The rest of the bank holding companies aren’t in that league in a meaningful way.

Prior to the 1920s there was a separation of commercial and investment banking which was stipulated under the National Banking Act. In the heyday of speculation of that era, it was repealed. Due to the collapses set off by the use of leverage and banks bailing out their lending customers by securities underwriting sold to their depositors, the Glass-Steagall Act was passed. Ten years ago the Graham-Leach-Bliley Act repealed two of the four sections of the separation of commercial and investment banking law. This week, Senators John McCain and Maria Cantwell introduced a bill to return to the separation. Something is going to happen. I will be watching it closely not only as a concerned citizen, but also as a portfolio manager and investor in a financial services hedge fund. Currently we have no positions in banks that are primarily commercial banks. We expect both long and short opportunities will present themselves in 2010 and beyond.

Bottom line: I see a market for opportunists in 2010 on the one hand and not a bad market for long-term investors on the other hand.

Ruth and I wish our readers and their families a very Merry Christmas.
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Next week I would like to focus on what I see in terms of mutual fund trends that will be of use to our members.

Please let me know your own thoughts on these topics.
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