Biggest Investment Hurdle: Complexity - Weekly Blog # 913

 

 

 

Mike Lipper’s Monday Morning Musings

 

Biggest Investment Hurdle: Complexity

 

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

 

 

 

 

First Priority

An investment priority should be logging changes to your investment policies, although most investors do not maintain such records. To paraphrase the late and great Charlie Munger said that Warren Buffett was a learning machine. His point was, Warren benefited from the losses he sustained. He had an investment history of making very few repeated mistakes.

 

Most profitable investors also make relatively few mistakes, in part due to most mistakes forfeiting more opportunities than money. To avoid future mistakes, it would be helpful to have an insightful roster of mistakes. The real painful mistakes are repeaters.

 

Tools of Repeating Errors

Many repeating errors of judgement rely on an automatic mathematical response. For example, if “x” happens then do “y”. This is a non-thinking action. It does not adjust for changes in critical conditions that might impact the current situation.

 

On a very basic level, buying is different than selling. Investment buying is often based on market prices being wrong but are likely to change soon. The seller on the other hand believes in the relative attractiveness of a security that will shortly decline in price. In both cases the investor believes that he/she is ahead of the bulk of the investment market. These are the actions of someone who wants to be among the leaders.  This is in direct conflict with successful investors who prefer to be lonely and contrary to the crowd.

 

Understanding Complexity

Berkshire Hathaway (*) developed a system of categorizing new investment information into three buckets, “yes, no, too hard”. Berkshire’s advantage was structured on the combined experience of the late Mr. Munger and Mr. Buffett. This experience included knowledge of over 60 different companies they owned and the knowledge of various securities they previously owned or looked at for more than 100 years combined. Where most others saw complexity, they saw investment opportunity.

(* Berkshire Hathaway shares are owned in client and personal accounts.)

 

Can’t Avoid Complexity

In the modern global world, one cannot avoid complexity. However, with some hard work and experience you can reorder many elements into positives, negatives, and judgements to be determined. With this structure one can put odds on each critical item, leading to a preponderance of positives or negatives worthy of action.

 

An example of factors that surfaced this week in the media are shown below:

• Wall Street Journal Headline “Foreign Stocks outperform S&P…”. This could cause many US accounts to add foreign stocks and funds. However, the largest collection of stocks that Americans buy are multinational stocks listed overseas. In many cases the largest portion of these portfolios are invested in US operations, which is a negative if your purpose is to participate in European and Asian growth. (The same could be said about US listed multinationals with significant sales abroad. This includes Coca Cola, a large holding of Berkshire. The same could be said about Apple.)
• The Federal Reserve is concerned about a bifurcated economy consisting of technology and older companies. Both sides have significant foreign sales.
• This may be the wrong time for the proposed cut in bank supervision. Both banks and non-bank financials are increasing loans to lower-quality companies.
• While some believe oil is being priced attractively, natural gas prices are even more attractive. Also, Copper has historically performed better than gold.
• The “Buffett Premium” is disappearing just as insurance driven earnings are very strong.
• Cash in portfolios should be used in the short term, either as a basket to buy favored stocks or to reduce exposure to over-capitalized companies and increase return on equity.
• In latest week there were more declining stocks than rising stocks.

 

Each of the mentioned items could be attractive buy or sell opportunities, depending on one’s view.

 

What do you think?

 

 

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

 

Mike Lipper's Blog: Signals of Change in Historic Patterns - Weekly Blog # 912

Mike Lipper's Blog: Where Are US Stock Prices Going? - Weekly Blog # 911

Mike Lipper's Blog: A Good Time to Sell? - Weekly Blog # 910

 

 

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A. Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

Bad Comparisons Can Lead To Faulty Conclusions - Weekly Blog # 905

Mike Lipper’s Monday Morning Musings

 

Bad Comparisons Can Lead

To Faulty Conclusions

 

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

 

 

 

Your Portfolio vs. Stock Indices

The biggest trap the media and sales community set for both institutions and individual investors is comparing portfolio performance with a stock index constructed by a publisher. The best US stock market index is probably the S&P 500 Composite (SWX is its symbol).

 

The index is published by Standard & Poor’s Global (*), whose components are selected by data analyst editors, not investment managers. In a performance year where a company splits into two or more publicly traded stocks; the index carries each component of the former stock for the performance year. That is why the SWX measures slightly more than 500 stocks at times. Additionally, almost every active investor’s portfolio contains some cash or similar instrument. In periods of large gains or losses, the performance of non-equities will affect the performance of an account, but not the index. Furthermore, it is extremely rare for an active portfolio to own anywhere close to 500 names.

(*) Owned in client and personal accounts

 

In measuring the performance of the SWX, the measurement compares the closing trade price of the prior trade date to the ending price of the current day. It is extremely common for the ending price to be higher or lower than what an investor receives, so the actual performance of an active account is likely to be different than an end price calculation.

 

The management committee of the Wall Street Journal and the Standard & Poor’s editors have decided that SWX will only contain stocks that are listed on US stock exchanges. They also do not limit the percentage size of holdings in the composite, while the SEC limits diversified mutual funds to holding no more than 5% weighting within the portfolio of any given stock at cost (not market). Non-diversified funds are not restricted this way.

 

In today’s world, managed accounts are almost certain to hold cash or fixed income instruments as redemption reserves. Additionally, opportunity reserves will in many cases include non-US listed securities.

 

Many years ago, for these reasons, we convinced a number of outside directors of mutual funds to compare the performance of their funds to similar portfolios of funds. I believe this is the way almost all investment accounts should be measured, whether they are funds or not.

 

Other Mis-labeling

Last week, three of the five leading large-cap stocks were labeled financials; JP Morgan Chase (*), Morgan Stanley(*), and American Express(*). None of the articles I read mentioned that Charles Schwab(*) was the fourth largest declining large stock on Friday. Clearly, Schwab has something else going on that the first three do not, despite sharing the same industry label.

(*) Client or personally owned

 

Also last week, there was no mention of various countries whose local market indices showed gains, Europe 6 and Asia 12.

 

Another example of incomplete labeling was a headline of Goldman predicting that “Gold will hit close to $5000, if Trump undermines the Fed”. Perhaps true, but other commodities and some foreign stocks may do just as well. (Coincidently, a strategic collaboration between Goldman and T. Rowe Price to create a range of public and private investments was also announced. As a part of this collaboration, Goldman will invest $1 billion in open market purchases of T. Rowe Price stock.  Perhaps the more important message, is that Goldman believes the market is not offing enough diversity.)

 

Question: What are your thoughts? 

 

 

 

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

Mike Lipper's Blog: What We Should Have Been Watching? - Weekly Blog # 903

Mike Lipper's Blog: The Week That Wasn't - Weekly Blog # 902

Mike Lipper's Blog: DIFFERENT IMPLICATIONS: DATA VS. TEXT - Weekly Blog # 901

 

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 – 2024

A. Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.