Change Expected - Weekly Blog # 806

 

Mike Lipper’s Monday Morning Musings

Change Expected

 

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

 

 

 

Unusual Items

• !200 CEOs give up their positions.
• Disappointing sales for LVMH among most of their 75 labels. High-end retail sales below expected results in almost all geographies, the most damaging being China and the US.
• Average ACT scores in the US are the lowest in 30 years, with Math scores of 19.5 out of a possible 36.
• Expect liquidity pool to shrink as consumers use up government cash. Will likely lead to market volatility.
• NASDAQ declines for the week, with 61% of prices down versus 50% for the NYSE. The NASDAQ has been the performance leader for some time.
• China is producing 49% of global shipbuilding and has 68% of ship orders. Some are high value and some high tech.

 

Most Logical Changes Expected

For some time, the mutual fund performance rank order has not varied much. Using the latest week through Wednesday and 5-year performance. Ranked by 5-year performance:

                    ---Performance---

                    Latest

                     Week      5-Year

Large-Cap Growth    +2.75%    +11.67%

Multi-Cap Growth    +2.40%     +9.19%

Medium-Cap Growth   +1.52%     +7.30%

Small-Cap Growth    +0.15%     +5.11%

 

International       +2.28%     +3.57%

Global              +2.00%     +2.62%                                                                                                                                                                                            

Point of View

Believing that we live in an irregular, cyclical world, I expect the domestic rank order to be reversed in some future market period. One reason is the current effort of the FTC to reduce M&A activity of large companies acquiring smaller companies in horizontal deals, which I expect to fail. I anticipate an increase in M&A activity in the financial services sector, which includes banks, fund management companies, investment advisers, and fintech operations. Highly effective salespeople will be greatly valued, as will critical tech people. There will be cross-border and cross-industry mergers.

                  

 

 

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Mike Lipper's Blog: Stock Markets Move on Expectations - Weekly Blog # 805

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Fire Drill - Weekly Blog # 782

 

Mike Lipper’s Monday Morning Musings

Fire Drill:

On board ships and in schools, why not in investing?

 

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

 

 

 

Any Smoke?

Implications: US stock index returns are almost normal for the full year if we use the year-to-date performance of the Dow Jones Industrial Average +7.16% and the S&P 500 +8.14%. Even the NASDAQ +18.64% is representative of a good speculative year, perhaps benefitting from short covering. The VIX indicator is almost asleep at 15.76, compared to 30 in past mildly troubling times.

 

There are some whiffs of smoke in the air, including a continuing 2 to 10-year yield inversion spread of 4.08% - 3.45%. Updating one of the oldest technical indicators with a more modern twist. In the latest week the 30-stock DJIA had 20 stocks rising to 10 declining, but the 20 transports split 6/14. (In the original Dow Theory, it was only the rails in the index. Today the number of rails has dropped, and a number of airlines, trucks, and other transportation securities have been added.) This could be significant if the normal buyers of rails, which are freight driven, are looking for future declines. 

Another group that appears to be worried are the CEOs of traditional financial services companies. The latest to announce a 10% layoff from both their investment banking and investment management functions was Lazard. (Mid-market M&A industry revenues hit a 9-year low in the first quarter.)

 

Publishers Note

The popular distinction between a recession and a depression is your neighbor losing his job in a recession and you losing yours in a depression. It can be helpful to explore the possible roads to a depression by focusing on the needs of securities analysts regarding layoffs. In focusing on the way companies handle layoffs, they should first be aware of the lost art of making money from bankruptcies. All too often layoffs are the first act of self-inflicted worsening conditions. Since they don’t teach about surviving bankruptcies today, they are unequipped to adequately analyze layoffs. (I admit the thought came to me in a recent meeting with the Dean of an upcoming Business School, where there are no classes on bankruptcies.) 

While a Columbia College undergraduate I was privileged to take Securities Analysis from Professor David Dodd, who was both an academic and investment partner with Benjamin Graham. David Dodd collaborated in producing the seminal work on Securities Analysis based on their experiences in the 1920s and 30s. It occurred to me that the whole basis for the course was the knowledge necessary for those who’d lived through the depression. This knowledge could be important in the coming era, and I will consequently devote the rest of this blog to the types of things one should look for prior to and during such a period.

 

The Fixed Income World is Different

There are two critical differences between fixed income and equity.

1. The first is the legal relationship. Fixed income is a contractual relationship with an initial investment, periodic payments, maturity, and rank in the order of payments in a bankruptcy.
2. Owners of fixed income securities are expected to be paid a pre-determined amount of interest and pre-payments of principal, as well as a final payment.

If payments are not delivered as promised, the default process is governed by the issuing documents. Things change dramatically when a bankruptcy begins. All debts immediately come due, sourced from the potential sale of all assets. Debts are paid in priority order, as specified in the issuing documents.

 

However, compromises are often made to get agreement from the holders of different classes of claims. This helps expedite payments rather than having to endure long, expensive court hearings. The size of the payments is a function of the price paid for the assets, less the costs of the sale. The cost of the sale includes the cost of highly specialized attorneys, accountants, and other experts.

 

Fixed income securities rights and privileges are senior to common stock rights. Owners of common stock will probably be wiped out, as there is generally no additional money to pay out after the senior debt holders have been paid. However, to avoid long and expensive court battles by equity owners, they will often be awarded a small amount of a subsequent new equity class.

 

What is a Bankruptcy Worth

Up to this time the focus has been on the current appraised value, usually in a quick liquidation. To the extent there is a belief that a “going concern” will survive bankruptcy, a different kind of analysis is needed based on the current use of the assets and their user in the future.

 

Growing up in Manhattan there were neighborhood cigar stores on many commercial street corners. They were good business in the late 1920s and became less good as time went on. By the early 1940s those businesses had effectively died. A chain of these went bankrupt, but their stock went up in price!!! The reason for this was that these stores were on busy corners and had long-term leases. A classic case of being worth more dead than alive.

 

There were a couple of cases of railroads who lost lots of money throughout the depression and went bankrupt. However, a couple of sharp investors saw a similar situation, as the railroads had considerable land along their right-of-way. In the WWII expansion of plants and military camps, these lands and their proximity to the rails became very valuable.

 

The unfortunate attitude of too many of today’s analysts and portfolio managers is that “value” is found on the published financial statements. To them, stock selling at a discount to book value is a bargain. In truth, book value is a collection of unamortized assets not written off. Because of changes in the market for a company’s products, the use of their facilities is less than their original purpose. For example, strip shopping malls in poor locations today.

 

What is not reflected in the financial reports are the developed new products, self-generated patents, a good sales force, key employees, etc. These are the types of assets we look for as investments.

 

The items mentioned in the last paragraph are critical in evaluating various layoffs. To the extent the layoff managers husband these types of assets I am not concerned, but if they are shedding valuable assets I am.

 

 

How Do You Evaluate Layoffs of Owned Stocks?

 

 

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My Outlook: Nervous Balances - Weekly Blog # 767

 

Mike Lipper’s Monday Morning Musings

My Outlook: Nervous Balances

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

 

 

 

Nervous Dilemma Positioning

My traditional allocation of stocks and bonds being close to a 70/30 split is somewhat misleading. A significant minority is in actively managed stock mutual funds with a financial services or international focus, often Asian. Financial services need a better label, so as to include two stocks of companies that are building their own portfolios that behave similar to variable annuities, Berkshire Hathaway and Apple. (The reason to call them annuities is that they are both primarily managed to produce long-term earnings, rather than current earnings.)

 

Financial services holdings as a group are also expected to fully participate in the growth of the US and International economies. In general, their strength is not in making loans, but in making money with equity. Consequently, one might characterize my equity investments as a combination of growth and value in more classical terms. This is appropriate as most companies have spurts of growth and value.

 

Time Horizons

For both my professional and personal/family accounts I start by designing portfolios built on an understanding (guess) of when and at what frequency the proceeds of the account will be delivered.

 

My particular situation is that I have a younger and healthy wife, with the fourth generation of the family begun. We are also committed to supporting the operational needs of a limited number of non-profits that Ruth and I have been involved with, both as volunteers and donors.

 

Short or Deep Recession?

I tend to look at various down periods through the late reporting of real net income (inflation/foreign exchange adjusted). Where possible, I prefer to use net operating income. Since 1970 the US has suffered 8 major declines of real reported income (-15% to -41%), with a median decline of about -28.5%.

 

The popular view today is that if we have a declared recession, it will be short and small. As someone who learned about odds at the New York racetracks I am nervous with popular views. Their payoffs are too small compared to the pain endured in the prior decline.

 

One theory of economic/market history is that declines are caused by imbalances, which are addressed during the recovery. If that pattern is followed in the next recovery, we may not yet have gone down enough. We need more time before the correction begins.   

 

The current path of major central banks is to follow the Federal Reserve Bank in attacking the supposed major cause of inflation with the only thing they can, short-term interest rates. The best definition of inflation is too many dollars chasing too few goods/services. The last two administrations contributed to these excess dollars, which were officially used to cushion the public’s loss of pre-COVID income with grants. (This was similar to the ancient Romans using bread and circuses to bribe people.) They are still at it!! This will make the Fed’s job more difficult and expensive.

 

Fewer people working should also drop the level of demand. However, despite all the increased regulation and required business spending, there are approximately 1.7 employees wanted for each current worker. This has created a situation where job switchers earn more than those who stay put. (If one really wanted to eliminate excess demand you could simply reduce restrictions on business.)

 

Thus, a shallow recession could be shorter if the federal government wasn’t playing both sides against the middle. This may happen later this year with their hope of a meaningful recovery by Election Day 2024.

 

Assuming this case, financial markets could start up as soon as economic indicators hit a bottom, with smaller declines. Which could happen this year. If this were to happen, our 70% equity stock fund portfolio would produce a nice but not great return. One area to consider for investment are funds that have lost money over the last 10 years through January 12. In general, these funds were victims of a strong US dollar. Included are funds invested in commodities, emerging markets based in local currencies, Latin Americas, and precious metals.

 

Second through Fourth Generations

While a recovery based only on lowering inflation and interest rates will generate returns for my wife and me, it would have little impact on succeeding generations, including various long-lasting charities.

 

The larger and longer-term problems that will reduce returns for succeeding generations will not be addressed by the level of interest rates. Most of these problems are related to people rather than numbers. These problems could be expressed as “Better for customers, workers, and owners”.

 

Below is a brief list of imbalances that should be addressed:

1.  Quality of leadership in each sector and operating unit of society, including levels of governments, segments of health and medical, education, and non-profits.

2.   Middle-class income as a percent of national income returning to levels of the past.

3.   Measured and productive population growth.

4.   Appropriate education for current and future needs.

5.   Governments of the people, by the people, and for the people.

 

Perhaps for the benefit of succeeding generations the appropriate investment strategy should include less exposure to risk until there is a deep enough decline to correct for imbalances.

 

Please tell me what you think?

 

 

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Mike Lipper's Blog: Next Election vs. Future Generations - Weekly Blog # 766

 

Mike Lipper's Blog: Bear Market, Recessions, Reinvestment - Weekly Blog # 765

 

Mike Lipper's Blog: Week in Conflict Leads to Buy List - Weekly blog # 764

 

 

 

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What Is The Problem? - Weekly Blog # 702

 

Mike Lipper’s Monday Morning Musings

What Is The Problem?

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

Where are we?

As we enter the third quarter, often a good performing quarter, US stock market volume is underwhelming. Apparently, declining confidence in global political leadership has led to a fall in investor confidence. In the latest week, each of the six best performing funds had a different investment objective. In fund performance order they are: Managed Futures, Flexible, Tech, Financial Services, Natural Resources, and Precious Metals. This suggests no common theme or the likelihood of similar stock positions. Thus, success is likely the result of critical skill in stock selection, not sector or market selection. A similar focus is seen in fixed income, where corporates are outperforming governments.

The American Association of Individual Investors (AAII) weekly sample survey of members is showing no enthusiasm for either a bullish or bearish future for markets. This survey is often a reliable contrary indicator for the next six month’s performance. Of all the indicators reviewed, the only one that’s relatively strong is the Barron’s Confidence Index, which favors stocks over bonds.

In general, I believe actions speak louder than words, particularly from members of the investment/financial community. This week I am seeing an increasing number of respected firms uprooting their employees and moving to Texas or Florida, not just for lower state taxes but for a better lifestyle. In addition, within the fixed income world there has been a considerable shift of investment people from one well known large employer to another. I am also noticing various product lines being transferred from one insurance company to another in the insurance sector. There are undoubtedly specific reasons for each of these shifts, but underlying each shift there appears to be a view that the future will be better for employees and their clients at their new firm. 

Should we be looking at longer periods and seeking different clues? There are brief lessons from Rome, Netherlands (vs Spain), England, and the USA. If we apply these and other lessons, we can handle our competition with China long-term.

Rome

For hundreds of years Rome was the dominant power in Europe, North Africa, and the Middle East. It was the technological leader of the world based on its mastery of building roads for military chariots and commerce. Rome was also the builder of aqueducts bringing water to Mediterranean cities. 

Rome was brought down by its own invention of “Bread and Circuses”. The political powers in Rome provided bread and free entertainment to its supporters in their arenas (circuses). In effect these were bribes. These “gifts” to the population of Rome, the tributes from conquered lands, allowed many Romans to not work. The history of great empires like Rome is that they fell due to internal pressures and the unwillingness to properly defend themselves. Thus, the great Roman Empire was defeated by bribes that weakened their will to survive.

Netherlands

The country fought a series of wars to free itself from the threat of occupation by the much larger and richer Spain. It was essentially a war between Spain, with its import of Latin American gold wealth, and the aggressive Dutch merchants who worked together. (One of the classic paintings of this era shows a group of merchants serving as night watchmen to alert their community to the danger of fire in their midst.) These merchants were inventive, creating the first stock exchange. They were also early in developing funding vehicles such as trading companies servicing their established colonies in South America, Asia, and Africa. Robeco also successfully built the first self-managed and owned mutual fund, way before the late Jack Bogle’s Vanguard. 

When I was a junior security analyst at Burnham, there was great respect paid to the firm’s Dutch clients who were believed to be very savvy judging risk. (I remember commenting on one occasion that the Dutch were selling shares in a Dutch international company to the Americans. It seemed to me that the locals were right, and they proved to be.) 

From a small geographic base and only a merchant fleet, they established a number of large international companies and colonies, without the benefit of a strong military. This proves that under the right circumstances merchant power and expertise is equal to or better than a strong military base. Even today, Dutch financial companies “punch” way above their geographic weight.

England

England, or more precisely the United Kingdom, is another former global empire from a small country with limited natural resources. Like the Dutch, they were early in building a savings industry, which is now a world financial power. The country has also produced more legal principles than any other in the world. While The Magna Carta was only between the King and Nobles, it proved to be the foundation of the concept of limited government. 

The English did something few countries have done, passing the crown three times to leaders born outside the country, and it worked well. The political establishment has also yielded to a popular view other than the sitting government. (While we celebrate the US victory at Yorktown as the end of the American Revolutionary War, a peace treaty was signed in London before the battle even began. Without electronic communication, America had to wait for a ship to arrive with the news.) The change in London was led by prime minister William Pitt, the Younger, who deemed the war too expensive relative to the value of US trade. The long war was difficult to win, so the finest military and navy conceded. Only great leadership of a country has the strength to recognize changes have taken place that require a change in policy.

USA and Prohibition

Almost as soon as elections were held in the cities of this country, it was common for some political groups to offer alcoholic drinks to would be voters. A small-scale throwback to the “bread and circuses” of Rome, but still a type of bribe. When the temperance movement gathered steam I suspect it received some support from those who felt gifted alcohol on election day may have changed some votes, particularly in big cities with lots of new voters. 

Much like with William Pitt, the Younger, popular opinion turned against prohibition when policies needed to be changed in the 1930s. It probably cemented the “wet” politician relationship with bootleggers, speakeasy proprietors, their suppliers and customers. Even after Prohibition, the only places in New York state to get a drink on election and primary days were locations independent of New York law, the Indian reservations and the dining room at the United Nations. This demonstrates the US can change policies when the perceived facts change.

China

I believe the current leadership in China is largely consistent with its history, demographics, and its financial structure. Approximately 90% of the people living in China today are descendants of the Han Chinese, the remaining 10% comprised of approximately 55 other national groups. While many of these groups have lived peacefully in China for hundreds if not thousands of years, they are viewed as potentially disruptive by the central government. Based on these concerns I believe the government does not want to add new nationalities into China. Because the Nationalist government fled China, they view Taiwan as largely Han Chinese. If I am close to correct, I do not believe Xi wants to occupy other countries. However, it is afraid of being trapped by unfriendly neighbors. That is why they want them to be friendly and not be controlled by other world powers.

Xi has other problems, including incipient competition funded by some successful businesspeople. He is very conscious he’s in a race against time, with the population aging and not replenishing itself.  The Chinese are prodigious savers who’ve had little to spend their money on and a heritage of living rurally with weather/crop cycles. Within family groups and some small communities there is a combination lottery lending mechanism, allowing the winners to jump to a higher economic level. In aggregate Chinese savings are enormous, funding both business and various levels of government.

The best way for the US to become more competitive with China is in some respects to copy them. Currently, our political leaders measure our success by the amount we are spending on goods and services. Although this provides current value, some consumption has no value long-term, causing this country to fall further behind as a saving society. The US government should switch its emphasis to saving for the future, where we are very much underfunding retirement. Additional savings would push up savings income and attract Chinese investors anxious to diversify their investments.  They are all conscious of the risks in their own over leveraged society. 

If we are able to do this, we would accomplish what my wife describes as a double win, benefiting both the Chinese and the Western investor. Such an occurrence would generate a lot of confidence.

Why Now?

While many people talk longer-term, most of their psychic and financial income is relatively short-term, impacted by their own expected tax rates. The future is almost never crystal clear and for many it has become either less clear, less attractive, or both.

Near-term elections over the next three years may provide some answers, or they may not. It will depend on leadership characteristics changing from the standard politician’s focus on the next election and those of statesmen or women focusing on future generations.  

   

What do you think?    

 

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

https://mikelipper.blogspot.com/2021/10/the-confidence-game-weekly-blog-701.html

https://mikelipper.blogspot.com/2021/09/two-confessions-weekly-blog-700.html

https://mikelipper.blogspot.com/2021/09/observations-prior-to-excitement-weekly.html

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Managing Mistakes - Weekly Blog # 652

 

Mike Lipper’s Monday Morning Musings

Managing Mistakes

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

Mistakes are common in all endeavors. That is why we should learn from them and raise the fundamental question as to why we don’t. In the US we have entered a two-month period where almost all the candidates make mistakes due to oversimplification, incomplete statements, over-worked staffs, inexperienced candidates, etc. Some of these unforced errors will cause a few candidates to change their preferences.

The political world should learn from the experiences of both the sports and military worlds. Most of the time the declared winners are the side that makes fewer mistakes at crucial points. On a win-loss ratio, General George Washington lost more battles in the American Revolution than he won, particularly in the earlier years. He won at Yorktown because he benefited from battles won in the South by other generals using fewer European tactics. Additionally, weather in the Atlantic allowed the Allied French fleet to depart from New England and kept the British fleet harbor bound while British politicians in London grew tired of an expensive war.

How does this focus on historic mistakes apply to portfolios? Like most American election choices which are already made up, most portfolio owners are sticking with their plans. Modified only after the election as a result of foreign political changes. 

The Crux of the Problem: Unrealistic Plans

Some individual and institutional investors are unhappy with their portfolio results and are seeking to make small adjustments. There is rarely an almost perfect portfolio than can be converted to complete satisfaction by the change of a single security or fund. The crux of the problem is addressing multiple needs with a single solution. Most often investors have a diversified portfolio in mind, but due to an emotional need to be with the crowd their investment performance is closer to that of the popular indices.

True diversity can only be accomplished long-term by a collection of winners and losers at different points in time. In our everyday lives we are both self-insurers and hedgers, taking on physical risks at home and at work. While we may have fire and auto insurance policies, they are unlikely to pay off enough to totally substitute the new for the old. In effect we accept the shortfall as part of the bargain embedded in the contract. In other words, we chose to tolerate less than complete perfection. Yet in our portfolios we wish to avoid any deficits in actual or relative returns. Understanding how the markets and life rotate disappointments and mistakes hopefully gives us the opportunity to own winners where the gains are much larger than the mistakes.

The so-called mistakes may quite possibly be insurance premiums to be activated in future periods. I therefore favor dividing a single portfolio into parts, first in terms of risks and second in terms of desired delivery time. If one has only a single portfolio then any “mistake” is a negative, whereas a portfolio that addresses different levels of risks or different time periods provides some insurance. Today’s risks include changing tax rates, materially higher inflation, fall of purchasing power due to currency changes, technological changes, management changes, political changes, medical and health conditions, and the unknowns.

Could This Be the Time to Change?

One of the disadvantages in pouring over current data is that whatever occurred recently has little to do with what will occur subsequently. Nevertheless, the performance of equity oriented mutual funds for the week ended last Thursday could be indicative of future directions. In contrast to the slight decline of -0.85% for the average S&P 500 Index fund, 87 fund peer groups did better. The five peer groups averages that did best included: Base Metals Commodity Funds +2.49%, Latin American Funds +2.46%, Financial Services Funds +1.87%, Utilities Funds +1.58%, and Agricultural Funds +1.38%. I know of not a single portfolio that holds all five weekly leaders. The only common denominator is that these groups underperformed the S&P 500 for a considerable period of time, as did most of the other 82 peer groups. 

This is not only a US phenomenon, of 44 markets in local currencies only 15 Ex US markets gained, including 2 European markets (Moscow and Spain). In contrast to many of the pro-inflationary funds groups, the average 6-month money market deposit account interest rate declined to 0.19%, down from 0.22% the prior week and a three year high of 0.72%, signaling that many banks cannot find secure borrowers to lend to.

One additional symptom of a speculative market producing a lot of gains for some nervous holders is the change in trading volume on a year over year basis. NYSE listed stocks +7.84%, DJIA stocks +46.09%, NASDAQ +84.86% and Dow Jones Transport stocks +186.19%. Traders of volatile stocks are likely to look for future volatility.

Working Conclusions:

Clear investment answers are not likely to be revealed immediately after the US elections. I suspect we will be in for a period of excess volatility that will attract more cash off the sidelines. This uneasy period is not likely to end until most if not all the cash has been consumed. While this frenetic period continues, there will be time to transform a single portfolio into a collection of portfolios based on different needs and risk appetites. All portfolios should have sufficient reserves to absorb the mistakes that will occur without hurting the investment objectives too much.

Question of the Week? Are your ready for Changes?     

 

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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

https://mikelipper.blogspot.com/2020/10/what-is-nasdaq-saying-to-whom-weekly.html

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Momentum is Slowing under Too Many Cross-Trends - Weekly Blog # 651

 

Mike Lipper’s Monday Morning Musings

Momentum is Slowing under Too Many Cross-Trends

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

The human mind prefers simple actions leading to success in order to address present issues. As a professional investor with fiduciary responsibilities, that is what I want. However, the discipline of preparing a weekly blog does not often lead to straight-forward conclusions. This is such a week and the best I can do is to briefly outline the various cross-trends that I perceived. I ask subscribers to select the options that direct them to an investment conclusion, which hopefully they’ll share.

The following is a list of the trends in no order:

1. Seeing signs of smart professional bottom fishing buyers in Energy, particularly natural gas related and an array of financial services-banks, funds, brokers, and service providers.
2. A minority of professionals appear to be bullish and a sizable minority of the public are bearish. The rest are confused and waiting for direction, with more than normal cash reserves.
3. Myopically cheap securities can be value traps due to outmoded statistical measures and/or inappropriate timing.
4. Alibaba, Ant Group, and Tencent’s securities are being found in  institutional portfolios. These groups are becoming more global rather than focusing on Chinese holdings. (Almost all companies are influenced by trends beyond their headquarters’ locations, some more than others.)
5. In the weekend WSJ, only 42% of price aggregations rose this week.
6. “More than 40% of total US equity trading volume now takes place outside of public stock exchanges”, according to the Chicago Board Options Exchange.
7. The NASDAQ Composite gained +0.79% and the NYSE Composite declined -0.63% this week. As there is less passive trading in the NASDAQ relative to the NYSE, I believe it is a better indicator of professional investors thinking.
8. The JOC-ECRI Industrial Price Index is up +6.69% from a year ago, signaling inflation.
9. For the week, the average Large-Cap Growth Equity Fund was up +1.81%, S&P 500 index funds were up +1.07% and Value funds were down -0.29%. Not the expected change in momentum pundits were expecting.
10. According to the National Bureau of Economic Research, most stimulus payments were saved or applied to reducing debt. Hedge fund performance fees do not protect investors from paying for poor performance.
11. PwC’s view of the World in 2050 is based on the following points: 
• World GDP will double by 2037 and almost triple by 2050.
• China is already the largest based on currency purchasing power(CPP) on market exchange rates (MER) and will be number 1 in 2028. 
• India will be the 2nd largest in 2050 (CPP) and 3rd in (MER).
• Mexico and Indonesia will replace the UK and France by 2030.
• Nigeria and Vietnam will be the fastest growing by 2050.
• There will be a significant gap between the top three: China, India, and the US vs the rest.
• The US will remain the wealthiest.

Working Conclusion:

Some of these observations may prove to be useful to long-term investors, but probably not all. The timing of their value is also uncertain. I therefore suggest you have a global orientation with a reasonable amount of liquidity (cash or highly liquid stocks). Any high-quality fixed income holdings beyond a 2-year maturity could be a burden. The appropriate investment objective is to first avoid losing purchasing power, with an additional reserve for being wrong. The second objective is to build capital opportunities in a number of places and different vehicles when possible.

Questions for the week:

1. What do you think of the list?
2. Will anything mentioned cause you to make any changes?
3. What are the other trends we should be tracking?

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

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

https://mikelipper.blogspot.com/2020/10/what-is-nasdaq-saying-to-whom-weekly.html

https://mikelipper.blogspot.com/2020/09/there-is-incredible-shortage-weekly.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Short and Long-Term Opportunities with Risks - Weekly Blog # 593

Mike Lipper’s Monday Morning Musings

Short and Long-Term Opportunities with Risks

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

Mid-course corrections and structural changes represent both opportunities and risks. Opportunities and risks are rarely separate from each other. My process for dealing with each, travel along similar routes:

• Early, but not too early recognition. (Statistically there is not much difference from a discovery that’s too early and being labeled wrong)
• Identify the magnitude (Large to life-changing vs. time and reputation risk, which can’t be recovered)
• A research plan to narrow the number of opportunities and risks. (We can’t deal with too many variables)
• An initial plan of action (Casualty lists are full of those who were too motionless)
• Frequent adjustments to the plan. (Frequent but not too frequent, there is time needed for others to react reasonably)
• Listen to both extreme historians and futurists. (They are often the same)
• Create short-term achievable goals. (A passing grade is better than 100%, from which you can’t learn)
• Cut the losses when other opportunities appear with lower risks. (Most great discoveries/inventions are bi-products of research efforts seeking other solutions)

Subscribers could use the above principles in reviewing what comes next.

Mid-course Correction?
US stock prices since late July have violently fluctuated in a trading range, as measured by the three major stock indices.  At the lowest point they were about half-way to a normal 10% correction. As of Friday, they were within a good trading week to their former peaks, achieved in July: Dow Jones Industrial Average -2.05%, S&P 500 -1.56%, and NASDAQ Composite -2.73%. This blog is prepared for long-term investors and I am therefore not going to focus on the momentum driven traders that dominate the market these days, especially when long-term investors are nervously enjoying gains generated over the last ten years.

While the market and economies are not driven by the calendar, investors and the media tend to focus on annual returns. I am concerned that while most stock and equity fund investors have not yet reached a gain of 20% year to date, a large number have. I am wondering whether the market indices will go through their old highs with some enthusiasm, or whether they will be stuck in a price range with high volume, encouraging some equity investors to take some chips off the table and wait for the clarity they expect in November of 2020.

This is not a political judgement; one expects to see some damage from low interest rates and falling currencies. These investors should remain equity investors in stocks and funds, perhaps with some rearrangement of their choices. However, under no circumstances should they have less than 50% invested in the stock market, re-entry costs and tensions are high for taxable investors.

Fundamental Changes for Long-Term Investors
There are two very important changes that are likely to impact successful investing in the future:

• The appropriate nature of invested capital
• Fewer workers and more mouths to feed 

Adapting to the Changing Nature of Capital and Investing
The earliest identified capital included physical things like land, jewels, and weapons, etc. One could see them, and an experienced person could evaluate their worth. Thus, the earliest recorded loans were mortgages or collateral. The wonders of double entry accounting recognized an assets value as the residual of its depreciated cost. Thus, the earliest investors concentrated on collections of assets, which led to analyzing balance sheets. This may well be appropriate in a world where the physical reality of assets is well understood, but that is not the reality today and increasingly it will be less so in years to come. Over one hundred years ago JP Morgan, himself that as a banker, made loans based on a person’s character, not their collateral. Nevertheless, today we still group companies in terms of their manufactured products, while our politicians focus on manufacturing jobs and their related products.

The service sector has been more productive in the production of wealth than the manufacturing sector for some time. Matter of fact, most successful manufacturers are also good at providing service and arranging financing for their customers and themselves. I would certainly include salespeople as being service workers, both within and outside every business today. We have entered a low interest era which appears to limit profitability.  Some wonderful old companies having more physical constraints are producing well respected brands but have suffered sales and other problems leading to significant layoffs. Some of these workers will retire or leave the industry, others will go to competitors in much smaller and more specialized elements of their industry. I see this occurring in older tech, pharmaceutical, and financial companies.

For many years CEO’s have thanked their most important asset, their employees, in their annual report letter. Since recruitment has become an important responsibility of senior management, critical employees are identified as “talent”. To those who think about these things it creates a dilemma. Do we as customers continue to rely on highly respected brands, or do we seek out products and services from which organizations are supposedly attracting the best talent? We face the same question as investors, especially the choice of colleges for those with children and/or grandchildren.

As an investment manager using financial services stocks and diversified mutual funds from around the world, I deal with this problem daily. A good long-term investment in these arenas needs good portfolio managers, salespeople, and good administrators. It also needs top management who wishes to have these people and can manage them, which is not easy. The problem today is dealing with the layoffs. The Financial Times noted that trading and advisory revenues dropped 11% in the first half of 2019 for the 12 largest investment banks in the US and Europe. We have seen most of these businesses shedding people, many of which were servicing and supporting the investment and wealth management efforts, both for their own companies and external clients. The people I know are looking because they have been laid off, or because they see significant elements of decay in their shops and want a better home to practice their art. With these people I could produce the best investment team in the world, but it unfortunately won’t happen because these people aren’t capable of working well together.

I am currently focusing on a small number of turnarounds which have similar characteristics. In the past they’ve had some good performing mutual funds, good sales teams, and good administration that was largely done in house. What makes these potential turnarounds interesting is that they have retired their old management. They now have new management that is busy trying to hire the right people to run critical parts of their organization. While the companies I am looking at are publicly traded, the new top management is long-term focused and not looking to the next earnings report. Not all of them will succeed, perhaps none will. But if they don’t succeed in a reasonable time, they’ll not be able to attract the needed talent and will be forced to merge to save a limited number of jobs. Often the acquirers are not much better than the acquired, just richer. Some will be successfully turned around if they can benefit from what I see and show next.

Retirement is Necessary for Our Success in the Future
Barron’s had a cover story this week “How to Fix the Global Retirement Crisis”. It points out that in 2050 there will be more people over 65 than under in the US. Japan has already reached having 59% over 65, in the US we are at 38%.  I would suggest we need to find ways to keep able and willing people working. At the same time, we need to find humane ways to free up some of their jobs for younger workers who can do more with those jobs. Most of the time seniors are healthy and want to be active mentally and physically, if they have the financial resources to do so.

In some respects, the mutual fund industry is one of the luckiest of all industries. A substantial portion of its growth has come from external forces, usually the government looking after senior voters. In the US the federal government passed legislation which created individual retirement accounts, salary savings accounts (401k, 403b, and 457 plans), tax exempt mutual funds, and money market funds. Without these the fund industry would have been much smaller. Things are similar in other countries, but they’ve used different measures to aid their own fund industry. The leader is Australia, which mandates that 9.5% be contributed to superannuation funds, a number that is expected to rise to 12% in the future. If one combines that with a history of no recession for 28 years, future retirees can look to a sustainable retirement. Considering seniors vote more often than other age groups, one would think that the US government might address their needs.  This could even cause the interest rate of savings to rise to a level that would reduce future unemployment through sounder loans.

Investment Suggestions

1. Use the present market to clean up your portfolio of losers that are unlikely to soon return your cost.     
2. Focus new investments on companies attracting good talent.
3. Restrict brand buying to your consumer needs, not investments.
4. Be prepared for opportunities and problems.    

Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/09/excess-capital-less-equity.html

https://mikelipper.blogspot.com/2019/08/an-awkward-moment-with-frustration-not.html

https://mikelipper.blogspot.com/2019/08/short-term-recognitions-plus-longer.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.