We Have a Management Problem - Weekly Blog # 935

 

 

 

Mike Lipper’s Monday Morning Musings 

We Have a Management Problem

 

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

 

                         

 

The Founding Fathers Saw it

When unsuccessful in getting George Washington to accept the title of King they decided to name him President, a person who presides over others that are powerful. Notice, they did not choose Executive or Manager. Interesting.

 

Today, the elected leader of the country comes from the commercial world and governs as a Chief Executive. Interesting. The difference between the two labels is that the presiding officer needs to work with other elected officers and not command his or her views become absolute commands.

 

Different Styles = Different Results

The largest owner/leader of a private family company has only the marketplace or regulator that prevents almost complete dictatorial power. This is reinforced by having family members in the named positions. It is worth noting, rarely if ever is one of the senior family members hired away to run a separate public company.  Interesting.

 

One of the realities of managing a successful company is that senior people are often hired away to run competitive companies. GE, JP Morgan Chase*, and Apple* are good examples.

* Indicates shares owned in personal and managed accounts. Interesting

 

The Selling Problem

Emotionally, selling is much more difficult than buying. Afterall, buying is an act of new faith in both a stock and the individual making the decision. At the time of purchase the stock position is the single best bet the investor can make.

 

Selling sometimes involves disappointment in the stock or can be the need for account liquidity. It is like the pain of selling one’s children or losing a personal extremity, but at the time of sale it is the least loved stock in the portfolio. Emotionally it is relatively easy to set up a buying program that purchases a position over time, such as buying a certain number of shares each month for the next year as one gains conviction. However, selling is an entirely different mindset as it is painful to lose a limb or a child, the quicker the better. That may be why more shares have been sold at declining prices on down days for the last six months. Since selling is more emotional it probably makes tactical sense to sell over time. Interesting

 

Reasons to Consider Selling Programs

1. The US has the highest inflation rate of all the advanced economies.
2. Iran has a functioning economy, despite the bombing.
3. There are only 3 mutual fund sector averages that beat the +13.66% 10-year compound average of S&P 500 index funds; Science & Tech +17.82%, Precious Metals Equity +16.77%, and Large-Cap Growth +14.61%. My guess is that it is unlikely these three sectors will outperform the average US diversified fund’s return of +11.16%, nor will they produce double digit gains in the next 10 years.
4. The “Hyperscalers” are commodity players that depend on the long-term prices of fuels for their plants.
5. The Walmart (stock) Recession Signal +10.89% vs the S&P Luxury Price Average -14.8%.
6. Fixed Income strategies in the future won’t follow historical patterns.
7. The President has borrowed the most money and runs the government with biggest deficit. They are urging retail investors to buy debt securities.
8. Ray Dalio believes in the histories of recessions, concluding we are currently in stage five on the way to six.
9. Fitch has noted that the default rate on private debt has risen.
10. The ECRI industrial price index has risen to 135.06, which is a +14.21% increase in the last 12 months.          
11. Note: The job gains for March included jobs for healthcare, which require larger amounts of social assistance and produce less GDP per person.
12. Homer Jenkins Jr. noted in the WSJ that “Trump is a lame duck with low appeal and a surplus of voter distrust.” 
13. We won’t have peace in the middle east until Iran’s sponsorship of death and destruction in the US, UK, Europe, Mideast, Africa, and Asia ends.

 

Interesting. Be Careful                                    

                                        

 

 

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After Relief Rally, 3rd Strike or Out? - Weekly Blog # 889

 

 

 

Mike Lipper’s Monday Morning Musings

 

After Relief Rally, 3^rd Strike or Out?

 

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

 

Preparing for Rough Seas Ahead

We had a “Relief Rally” up to the close of the US stock market on Friday. Although most stocks rose, there was a change in leadership. Many of the best performers were the kind of stocks an institutional equity player adds to a portfolio to soften declining performance in a down-market phase. The leaders did not have the characteristics of stocks leading a brand-new Bull market. Everything changed late Friday, with Moody’s* announcing the lowering of its credit rating on US Treasuries from AAA to AA1.

* Moody’s stock is held in client and personal accounts.

 

Not a total Surprise

In a May 8-13 Reuters survey, 54% of bond strategists were concerned about the “safe haven” status of US Treasuries, a critical benchmark for pricing global capital markets. In April the same survey had 47% concerned. This was not the first group of worriers.

 

Consumer confidence in May fell to the second lowest reading on record. Regarding Moody’s US Treasuries downgrade, S&P downgraded the US Treasury credit rating in 2011, as did Fitch in 2023. Thus, the move by Moody’s is the third downgrade or strike. The next critical question is the nature and length of the expected decline.

 

Moody’s Answer

According to Moody’s statement, US credit “retains exceptional credit strengths such as size, resilience and dynamism of its economy and role of US dollar as global reserve currency.” Not surprisingly, the US government’s view is that Moody’s is looking backwards.

 

Expecting this retort, Moody’s focused on expectations for the future. They expect the Federal Deficit to reach 9% of the US economy in 2035, up from 6.4% in 2025. Furthermore, they expect government revenues to remain broadly flat, adjusted globally from negative. (To me this sounds like stagflation, with both tax rates and inflation rising.)

 

My Call

Odds are, we’ve struck out and ended the inning, but not the game. The absence of a structural recession/depression may keep an expansion in the low to middle gains. Portfolios with over 10% in longer than 10-year Treasuries should cut them in half.

 

How do you call it?

 

 

 

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Markets Are Time Frame Exchanges - Weekly Blog # 796

 

Mike Lipper’s Monday Morning Musings

Markets Are Time Frame Exchanges

  

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

 

 

 

Who is in Today’s Crowd

The bulk of investors are not currently active. August is normally a low volume month, but it appears we are not in normal times. There appears to be less conviction as to where we are going. A reasonable bet is that the majority of opinions regarding future direction are wrong.

 

This week we heard two opinions which the media suggested were in contrast with one another. Fitch lowered its credit rating on US Treasuries by one notch to AA+ from AAA, while Jaime Dimon stated that no large country has a stronger credit condition. Actually, they are probably both correct, the difference is in their function. The Chairman and President of JP Morgan Chase was reassuring depositors that the US government was currently the safest place to invest. Fitch as a credit rating forecaster, was suggesting future political battles within the US could delay the promptness of the US government in making payments on all its obligations. Both could be correct.

 

Jamie Dimon is probably correct that US government payment dates will not currently be violated. (This excludes delays in payments on various government contracts, which are not funded obligations.) Fitch raises the question as to when the political process in the future could lead to some delays. These are important concerns, but it is not the total picture as far as investors are concerned. 

 

A funder of the US government who will be repaid in devalued dollars due to high levels of inflation. An added concern is the foreign exchange value of the US dollar in a world that is increasingly measured in other currencies. Both geopolitical and economic factors may make the dollar worth less when purchasing essential items from overseas providers. (Energy, clothing, critical medical resources, etc.)

 

Looking beyond the next few years the picture looks less promising due to aging populations in the US and around the world. Both the US government and private sector are failing to build up the reserves necessary to pay retirees likely to have health issues. Historically, the next generation utilizes their working years to pay for their own retirement and the care of their seniors. That is not happening now. Many workers currently spend all they earn and do not focus on long-tern cash generation.

 

Other Disturbing News of the Week

1.  The current President looks to FDR as a great, if not the greatest, president. FDR believed his greatest achievement was the National Recovery Act of 1933 requiring competitors to meet and agree to wage rates for their employees. The higher the better. The act was ruled unconstitutional by the Supreme Court.

2.  The UAW is demanding the “Big 3” give their workers a 40% increase. (This is the same union that forced the US auto companies and their suppliers to raise wages, leading to an increase in foreign manufactured car imports and a decline in US auto exports.

3.  One investment adviser called to my attention an article by Bob Kirby, the great salesman from the Capital Group. His article, written in 1975, showed how each generation fails to learn from the past. Bob earned enough during his lifetime to endow 5 scholarships at leading universities, hoping to correct this situation. Caltech was a recipient of one of these Robert Kirby scholarships.

4.  Xi, the Chinese Leader, measures national success in terms of technical self-sufficiency.

5.  For the past week only 2 of the 31 Dow Jones-Standard & Poor’s market indices were up, these were select micro and internet services.

6.  Only 5 of the 72 price indices published by the WSJ each Saturday were up this week. Three were energy and two were currencies. Wheat and corn were the two biggest losers.

7.  A US Navy Petty Officer was caught supplying detailed photographs of an attack amphibious ship to a Chinese agent. (One of the many difficulties facing an amphibious landing on Taiwan is the lack of amphibious ships and their training. Over 60 years ago I served on such a ship as a USMC Combat Cargo Officer.)

8.  Last week, volume in NYSE stocks declined 59% vs. 62% for the NASDAQ.

9.  Major advertising agencies are cutting their estimates for the rest of this year because their clients are cutting budgets.

 

Conclusions

The Fitch credit rate cut was not the only bearish news that caught my attention last week. The comparisons with the FDR led Depression is a bit unnerving. What is clear is that while the bulk of the US focuses on the general movement of the dollar, many in Washington are focused on the probability of votes, particularly at the top of the tickets.

 

What are you seeing and believing?

 

 

 

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Leadership Change Late in the Game

Regular readers of these posts already know that I have been prematurely speculating about the risks of a top of the market. Most securities analysts date the last important bottom as of March 9^th, 2009. Almost exactly four years later, the Standard & Poor’s 500 Index (S&P500) reached a new high on the last trading day in March, 2013. Market cycles vary in length from bottom to peak, but generally they are in the 40 month range. (One of the sounder investment management organizations uses a rolling four year period as the shortest benchmark for its internal incentive compensation.)  Each market cycle is a bit different than those of the past, but they have many of the same characteristics. Most often on the rise up, the sectors that lead make sense as they come from deeply discounted price levels. In this particular case the second best performing group from the market cycle bottom was the financials, a group that is of particular interest to me. (I believe that a market boom needs to excite the owners of financial shares. With that thought in mind, I manage a private financial services fund that has been enjoying this rise because among the financial leaders within the S&P500 were Discover Financial, McGraw Hill, American Express and AIG. All of these, I have owned for many years.) 

Buyers need a quantity of sellers before they can push stock prices higher. The coming week or weeks will likely supply some sellers and some will say the doubling off the bottom is enough. Others may feel that after low double digit gains in the first quarter, the time would be right to lighten up on their positions. They would be urged to do so by those who insist that there should be a tight correlation between the prices in the market and their generalized view on the domestic and global economy. (As long as there are numerous economic pundits that are somewhere between wary to negative on the market, I can take a relatively relaxed view of the future for long-term investment accounts similar to what we manage.) 

The drivers so far

Arranged by the leading central banks, the best thing driving the stock market higher is the impact of the banks’ experimental policies to force interest rates to confiscatory levels. These efforts have done much to the maligned credit ratings which have proven on balance to be correct in the long run. Recognizing that it is almost impossible for a credit rater to speculatively lower credit ratings, they do provide a useful purpose of confirming current opinions as to the chances of timely payment of principal and interest. At the top of the credit rating pyramid is the Nine-AAA league composed of the sovereign debts rated AAA by S&P, Moody’s, and Fitch. According to the Financial Times the size of this pool has shrunk by 60% from $11 trillion to $4 trillion since the beginning of 2007. (US, UK, and France are no longer AAA rated.) The size of the drop is first a measure of the scale of the combined fiscal and monetary overreach by governments and the sharp reduction of the size of the pool of so called totally risk-free assets from a credit standpoint. The message delivered to investors is that there is relatively little in risk-free assets available, so if you want to earn a somewhat reasonable rate of return you must assume other risks in the bond and stock markets. 

As many of you probably already know, I spend a great amount of time analyzing mutual fund data. I do not pay much attention to the net flow data that combines the dollar totals of sales and redemptions, since I believe that the motivations behind each stem from very different needs. I do pay attention to gross redemptions. According to the Investment Company Institute (ICI), gross redemptions of equity funds in the first two months of 2013 declined $12.7 billion to $224 billion whereas gross redemptions of fixed income funds rose $21.6 billion to $ 141.9 billion. Strategic Income funds rose $12.8 billion in redemptions for the year to $65.7 billion, followed by increased redemptions in high yield and government funds. The Strategic Income fund bucket includes those fixed-income funds that can move from one type of fixed-income market to others. I believe that the shareholders are concerned that they were not exiting governments and high yield fast enough. My guess is that these figures are just showing a bit of nervousness on the part of some mutual fund holders; the largest single category of redeemer was institutional investors who redeemed $158 billion up $29 billion from the first two months of 2012. These numbers do not support the much-heralded great rotation out of bonds into stocks. I believe that thus far the biggest single contributor to the increased gross sales of equity funds is coming from a $121.8 billion increase in money market redemptions to a total of $2.4 trillion. Thus there is a reasonable chance that when individuals and their managers recognize that for the moment they shouldn’t fight the Federal Reserve, they could commit their assets that may well drive the stock market higher. Or they could decide that the risks are too high already in stocks. 

Need for new leadership

On the rise from the 2009 bottom, the leading large portfolio funds have been managed by value-oriented managers. They have bought and owned stocks of companies that were statistically cheap using the company’s financial statements as a guide. This is one of the reasons that the financials appealed to these portfolio managers globally. Many of these stocks were yielding an above stipulated inflation rate or would if permitted by the central banks. Other stocks that were found in these portfolios had rising operating and before tax margins. This was mostly achieved by capital and labor efficiencies in spite of limited sales growth. Without a global pickup in sales many of these companies will not be able to show earnings growth. This is exactly the problem facing those who need the stock market to move higher between now and the next Congressional elections. 

Possible new leadership

With fewer and fewer high quality bargains available the value-oriented investor is finding it is difficult to identify new large names. At the same time a growth-focused investor is being limited by the expected lack of volume growth. One possible area for future strength is broadening the concept of value beyond statistical value based largely on reported financial statements. I am suggesting an old merger & acquisition gambit of searching for strategic value.  Strategic value rests on a well-researched view of significant change. In an oversimplification, one could look at these opportunities through the eyes on the cash flow statements or a materially different earnings structure.

One of the key questions is: are there significant opportunities for the company and its peers to materially reduce their capital expenditures? As a relatively young analyst I spent time with an older leading analyst of aluminum producers. He became bullish on these stocks when the companies were shutting down the hot lines and factories. His bullishness was based on the idea that with less available competitive capacity, demand would force prices up until the next wave of expansion would take place a few years in the future. Airlines have followed a similar strategy through their mergers to reduce excess capacity. In a minor way we have seen a similar thought pattern in the financials, with the waves of expanding and contracting fixed-income trading and branch building. The final objective of these strategies is to use cash flow to pay off debt, pay dividends and shrink the number of shares outstanding. Some practitioners of these art forms have produced brilliant results. To some degree the asset allocation skills of Warren Buffett and Charlie Munger at Berkshire Hathaway^* and those of Leucadia^* fit into this model.  

Currently on offer are two very different investments with dramatic change elements. The first, alphabetically, is Dell. The question here is whether a change to a more patient capital structure and/or change in management can produce good long-term results. While it is possible, I personally have my doubts, as the original driver of these discussions was an embarrassed (or should have been embarrassed) shareholder. Those involved are more financial engineers than sustainable company builders. I could be wrong and this type of shareholder action could become a model for the new leadership. There are lots of candidates for this kind of operation, but not without risk.

The other stock on offer and somewhat a competitor to the first is Hewlett Packard which likewise has been gravely wounded by the computer wars and unfortunate acquisitions. The difference is that the current CEO is in an announced five year turnaround plan. She has solid marketing and management experience. I believe that it is clear that the future company will not be producing the same products if at all or in the same way.   

While less attractive to me is what I have called “the three M” Strategy. The three “M”s stand for McKinsey, (a consultant with a dubious track record of success; e.g., Enron), Merrill Lynch and Morgan Stanley^*. The two financials have used the consultant to provide cover for what their managements wanted to do and have hired former McKinsey partners. Both of the two operating companies are trying to improve their balance sheet by selling off elements of their empires to improve their balance sheet ratios. They are doing this rather than materially improving their products and delivery systems. Nevertheless, they may well succeed; I hope so, as they have a number of talented people on board.

Each of the three alternatives to build increased strategic value could be part of a new market leadership which I think is needed to go from the newly established highs to materially higher stock prices. 

^*Owned in both my financial services fund and personal portfolios

What Do You Think?

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