“Straws in the Wind”: Predictions? - Weekly Blog # 890

 

 

 

Mike Lipper’s Monday Morning Musings

 

“Straws in the Wind”: Predictions?

 

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

 

                   

 

Predictions

Ever since humans have thought about the future, they’ve looked for clues about what the future might hold. Since very few stocks can be purchased and converted back into cash immediately with a profit on the first transaction day, equity investors are essentially betting on one or more perceived futures. All we can do is guess what may happen.

 

Since regulators frown on future predictions, particularly those that guarantee future events, investors and analysts scan both the past and views of the future to guess what may happen. The following are brief thoughts which may help subscribers think about the future.

 

From the Past

In 1934, the US Congress passed the Reciprocal Trade Agreement Act giving the President (FDR) the ability to negotiate reciprocal trade reductions. (FDR, with the help of his “Harvard Brain Trust”, was authorized to accomplish this mission. While they proposed tactics from the left, the current President may draw his approaches from the right. Both could be labeled “activists”.)

 

Today, the History Channel showed a two-hour program devoted to The Crash, The Depression, and FDR's actions. It was well produced, simplistic, and narrow, but the key facts seem to be accurate.

1. FDR's 1932 Presidential election had surprising support from Republican leaders J.P. Morgan Jr. and DuPont, the leader of GM.
2. FDR blamed the Crash and subsequent Depression on Wall Street and Banks.
3. FDR turned on them, which changed the way the economy worked.
4. The economy was not in condition to fight WWII at the beginning of the war.

 

As we have been told "History does not repeat itself, but rhymes." In general, there are two types of recessions, cyclical and structural. The latter takes longer.

 

2025

A year ago, very few analysts and perceptive investors would have guessed which four mutual fund peer groups would now be leading the year-to-date race. They are Precious Metals Funds +42.95%, Latin American Funds +24.50%, Commoditized Precious Metals Funds +22.60%, and European Region Funds +20.61%. The first and third are clearly based on gold, but the gap between the two appears to be unusually wide. Latin American and European funds having similar performance also seems unusual.  From an overall point of view these results suggest we have entered a new phase or cycle, with the probability that last year’s leaders won’t lead again for a while.

 

There now appears to be a need to fill manufacturing jobs on an overall basis. This is distressing for two reasons. The first is that hirers can’t find the right people who want to work in their plants. The second is that the new factories this administration is counting on will have difficulty reaching the productivity and profitability levels the optimistic people in DC expect.

 

The London Stock Exchange regularly publishes I/B/E/S estimates of S&P 500 quarterly earnings. For the quarter we are in, their earnings per share prediction is that we will gain +5.8%, while growing net income +4.3%. The +5.8% is disappointing, but the +4.3% shows how much the market needs buybacks. Moving to economic analysis from securities analysis, the low gains in net income will not generate sufficient cash to pay for capital expansion and the introduction of new products and services.

 

The weekly American Association of Individual Investors (AAII) sample survey has recently turned slightly bullish, quite a jump in three weeks. The latest week bullish/bearish readings are 37.7% and 36.7%, compared to 29.4% and 51.5% three weeks ago. Two comments are appropriate. First, this time-series has a good long-term record, although it has been wrong at turning points. Second, individual investors should not be traders who get caught up in short-term volatility.

 

2026

Venture Capital funds are having difficulty raising capital from investors and lenders. I suspect this is also true for the broader universe of private capital funds. Investors in small and mid-cap equity funds have become used to private capital funds buying their maturing holdings.

 

One commentator wrote that Warren Buffett’s Berkshire (*) sold bank stocks and has not sold any of its positions in Apple (*), Coke, and American Express (*) in its latest report. These stocks are price leaders and should therefore do relatively well in periods of stagflation.

(*) Positions held in client and personal accounts.

 

Question: What will make you transact this year?

 

 

 

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Reluctant Excuses: TINA to FOMO; Good News: Historical Trends to Apple Store; Accelerating Momentum: Incomplete - Weekly Blog # 505

Introduction to FOMO

Changing sentiment appears to be a much stronger force than earnings taking the stock market higher. A couple of years ago, investors reluctantly were buying equities in the face of expected rising interest rates, relatively slow earnings growth, and expected political turmoil. Their excuse for this questionable decision was TINA, There Is No Alternative. Over the last fourteen months this excuse has given way to another symbolic abbreviation FOMO, Fear Of Missing Out. During these last fourteen months and the first week of January, 2018, the S&P 500 has not had a single month decline. Momentum has become the mantra for the buyers as well as the larger audience of holders. In the last calendar year the leading investment performance factor within the S&P 500 universe has been the momentum stocks that gained 28.27%.

Will it Continue?

This week we had two very insightful experts publish their views of the year ahead with clues beyond. Byron Wien published his annual ten surprises that he believes have at least a 50% chance of happening and that his wide circle of global contacts believe have less than a 33% of happening. One of his surprises is that the market will take a 10% correction during the year. He thinks that a recession will not surprise us until at least 2019.  Further he recognizes that there may well be other surprises during the year that none are expecting. Nevertheless, one could interpret his views that stocks markets in general will be well behaved.

The second very worthwhile piece published this week was by Jeremy Grantham of GMO. Jeremy by nature tends to be on the bearish side. Thus it is a bit surprising that he entitles his piece “Bracing Yourself for a Possible Near-Term Melt-Up.” While he does acknowledge that we could have a 20% decline that he believes would be helpful, he also does not see a near-term recession. Like Byron he sees the S&P 500 as going well into the 3000 territory. B/t/w, his firm has an equity fund that is among the leaders in the institutional league.

The odds are that these two gentlemen will prove to be correct and I hope so. However, when I mention odds I am force to think of the lessons that my experience bought at the major New York racetracks which can be briefly summarized as follows:

1.  Past performance is good to organize one’s memory, but can be less useful in predicting the future.

2.  Each race (Market) is different with different horses and conditions.

3.  Different odds lead to different earnings.

4.  It is not the number of wins that counts, but the size of winnings taken away.

 5.  As a contrarian one can win more money by occasionally betting against the crowd.

Good News: Historical Trends to Apple Store

One of the reasons to own rather than loan is that over long periods of time human life is generally getting better. Most of the time we don’t get this message from our political leaders and their supporting pundits. If there weren’t problems to be addressed we might not tolerate governments and their expenses. Thus, we do not see a lot of publicity about the long-term progress we have made some of which from an article by Max Roser can be shown below:

·       Since 1990 there have been 130,000 people fewer in extreme poverty every day.

·       Globally in 1800 there were fewer than 100 million that could read. Today 4.6 Billion can read.

·       In 1800, 43% of the newborns didn’t see their fifth birthday. In 2015 child mortality was down to 4.3%. Improved health and nutrition has made us taller and smarter.

·       These and other positive trends are continuing and accelerating.

Part of the reasons for this progress is due to technology which marches to its own drummer. Technology itself is driven by the desire for increased profit. I refer to profit not in an accounting or monetary sense, but a desire to improve one’s own life, often to improve the lives of ones for which the individual cares.

This thought occurred to me this weekend when I accompanied my wife to the Apple Store at The Mall at Short Hills. It was by far the busiest store in the mall with both customers, salespeople, support staff, and in effect, trainers. It only took a little more than an hour to exchange her watch for a different model and synchronized it with her iPhone. During that time I had a chance to look at a very diversified group of customers waiting patiently to be served and an equally diverse sales and service group on a packed sales floor. 

What occurred to me is that we were experiencing an ecosystem which is building loyalty and a knowledge base both for customers and a helpful, well-trained sales force. In many ways each person in the store was looking for ways to improve his or her condition in a personally profitable way. (The visit made me happy that I have been a very long-term shareholder in Apple and reinforced my faith in their eco-system in spite of periodic hardware and software glitches.) 

The potential of Apple and its good competitors to deliver very useful products and services addressing many of our unmet needs suggests to me the rate of human progress will accelerate in the years ahead and will probably benefit my grandchildren, great grandchildren and their children.

  

Accelerating Momentum: Incomplete

In a market that relies on sentiment to drive its momentum, one can not wait on published financial and economic results. One should be paying attention to what consumers at all levels and investors are doing as well as saying. Recently I have been commenting on the AAII weekly survey of a sample of its members. As I have said previously, a normal distribution of the individuals' opinion is roughly 40% bullish and 30% each for neutral and bearish. This week the bullish reading exceeded 59% and the bearish number was about 15%.Two weeks ago the numbers were 50% and 25% respectively. Clearly a symptom of accelerating momentum

The siren of the rising stock market has not sucked in all the available money that is fearful of missing out. The banks (particularly the small and regional banks) have not lost cash deposits to the stock market. As a matter of fact, this week the average money market account dropped its rate to 0.30% from 0.33% the week before. The drop may be caused by less demand for loans or possibly that some banks were bulking up their cash items for year-end statement purposes.

Some market observers and I are carefully watching the yields on treasuries. Each major stock market decline had rising yields as money sought safety away from actual or perceived credit risks. Some feel a ten year yield above 2.50% could be alarming.

What to Do?

If economist Jeremy Grantham is correct that we are in a “melt-up” and there will be a 20% decline before the eventual recession which could trigger a bigger decline one may want to shift some of one’s equity positions into highest available quality. That would not have hurt you too badly in 2017 when the quality component in the S&P 500 gained 19.51%.

At this time large market caps with reasonable balance sheets yield above the ten year treasury. Not a great deal of actively managed investors and high market liquidity can be used as bond substitutes. Because we can always be surprised I would own a bunch of these. They may include AT&T, GM and GE plus a few others. If one becomes addicted to investing in quality stocks for the long run, there are more in the small cap arena than elsewhere, but these are for investing not cyclical trading.

Question of the Week: Do you agree or disagree with my analysis?     

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Future Winners Found By One Word: Adaptive

Introduction

While securities analysts are essentially statistical historians, fortunes and reputations be they financial, business, political or military are made by change agents. Most of these changes are not self-evident initially to the change agents, but come about through seeing what is and most importantly what isn't obvious. Seeing what isn't is not enough for success. (Many of my security analyst friends are frustrated by their lack of confidence in the stock and bond markets because their valuation metrics are not working. They are not adapting to the markets structures and valuations and may miss out for a time.)

What is needed is a series of actions to create the somewhat poorly defined solution. For most of those that are called brilliantly creative, it has to do with adapting what already exists but re-purposing it for the new challenge. By definition these change agents are future-oriented and not content with merely repeating the past, no matter how cherished the past routes have been.

For lots of reasons, I believe we have entered a period when we will see new approaches to current problems. These approaches will cobble together some of the past elements with new understanding of the implications of technology.

Learning from the Military

The study of war should be about how to conduct new military operations better than the old methods. For many years the American Civil War was the classroom for the German General Staff. They studied the campaigns of Stonewall Jackson and William Tecumseh Sherman in particular. From them they adapted the concepts of maneuver and column movement. They applied these brilliantly during the first and second World Wars in Belgium, France, and Africa.

During the period between the world wars, our own US Maine Corps developed  both the Raiders doctrine and Personnel Landing Craft as well as the use of aircraft for close tactical support for frontline Marines. They were adapting some of what they themselves had studied against indigenous forces and what was present in the era, but would also be needed in the next global conflict.

Whether BREXIT Succeeds or Fails May Depend on Adaptive Approaches

The "Remain" campaign was based on the current economic factors. The "Leave" movement was based on what the English saw and didn't like.  Assuming an unfriendly divorce, the success of Leavers will depend on their ability to find new ways to make their society and economy survive and grow. Much of the Remain pitch is that the City of London, their one square mile financial district, will lose the right to "passport" their deals into the EU. In Saturday's Financial Times, Charles Leadbeater writes an article of five different scenarios for a post BREXIT era. They go from the collapsed City to London becoming the best of all major financial centers. The final one is dependent upon the people involved adapting to the situation with new technology, but in some ways also a throw back to the medieval Hanseatic League of northern, largely German Cities and London.

The Finance Minister of Luxembourg currently is warning the EU not to underestimate the UK. I believe their success will be the Brits’ ability to change the game by adapting some of the better practices and technology from around the world. As a contrarian with lots of time, I would rather be a buyer than a seller now. The new leadership is encouraging. However, as with all adaptations, there is likely to be some mistakes, but the failure to adapt is likely to be worse.

“Equity: The Film”

It is said that men traditionally resist change whereas women by nature are forced to be adaptive to change. One of the major corners of the financial community that has lagged behind the publicly traded investment houses and banks has been the Private Equity shops. Thus I am looking forward to the premier of a new movie entitled "Equity" which is about a private equity shop with a dominant  woman. The financing for the award-winning film was arranged by Candy Straight with twenty-five other professional investment women. We have known Candy since her days of heading acquisitions for a major pharmaceutical firm through a number of private equity shops and as an independent director of several mutual funds. These women are a great example of being able to adapt to difficult and challenging situations.

   

Large Cap Investments

My wife Ruth and I both have had a long term familiarity with the two corporate "Generals,” General Electric and General Motors. As a young analyst, I spent most of one year going through just about all of the major groups within GE. Ruth comes from Detroit and worked for a major auto parts supplier and raised money from the Detroit business community for the local symphony and local public television. Thus both of us have had a long term familiarity with the two "Generals.”

At one point I joked that the two should merge under the title of General Inefficiency. Clearly for many years the Generals lived in their own world and eventually lost earnings power, market share, and pride of place. But today each is in the process of evolving and adapting to both their somewhat reduced condition and also from more modern leaders.

In the past when I saw GE in a fund's portfolio (it was widely held) I treated it as an investment warehouse to store part of the portfolio until better investments could be found. GM couldn't shake the cyclical tag, and was far less owned by mutual funds, but was a comfortable holding for mutual insurance companies and trust banks. Both of the Generals evolved financial subsidiaries that traded on their parents’ credit rating and commercial relationships without outstanding success except as a recognition of their size. Both of the Generals today have evolved to somewhat smaller, but still giant, multinationals that are producing earnings on a regular basis from most of their activities. Both have benefited from adapting numerous of the business practices of overseas leaders.

Taxable Accounts Own Under 30% of US Corporate Stock

One of the characteristics of the US stock market over the last several years is that Large Cap stocks have outperformed the Mid and Smaller Cap stocks in price appreciation but not in earnings growth. Their attraction has been a throw back to the investment warehouse concept which is reinforced by superior liquidity. One of the reasons for the superior liquidity in the face of declining trading desk and floor capital is the shrinking direct participation of taxable individual accounts. In 1965, which was after my year-long research on GE, taxable accounts owned over 80% of US corporate stock. Today it is under 30%. The more, relatively small players in a marketplace, the safer it is for those in the center providing liquidity. Many of  the other Large Caps carry higher price/earnings valuations than the Generals and are equally challenged to find growing revenues. With both the Generals showing some signs of adapting to better business practices and hopefully accounting practices, their relative positions in the Mega Cap world could generate higher relative price appreciation from a historically depressed price level. The main reason that the Generals suffered the prior price declines (and in the case of GM bankruptcy) is their failure to adapt to present and future conditions.

Two Warnings

I have been stressing the need to adapt. This is not to be confused with a need to adopt. The difference is to add and modify one's own principles. Adoption is wholesale acceptance of the adopted views. This may well be the difference between a merger and an acquisition. Too often the second is one where the acquirer takes no prisoners. The acquisition is to do things the way the acquirer wants. A true merger is when both sides adapt to each other's thinking and procedures and there is a melding into a successful marriage. This is the exact opposite of the Broadway show with the title "I Love You, You’re Perfect, Now Change." The key is not capturing but working with.

The second warning is while I am optimistic for long-term investors, I am concerned by what I believe is a consideration that sidelined investors are now coming back into the market. For the first time in at least one year, many of the financial media outlets are celebrating that money is rolling into mutual funds. As usual, it would be useful to dig deeper. The entire gain in assets came from Exchange Traded Funds (ETFs). Most of that money went into a few fixed income ETFs. I believe the bulk of the ETF flow is from trading-oriented organizations. By the way, four of  the largest transaction volumes on the NYSE this week were ETFs. The money going into fixed income products now is unlikely to be long-lasting when interest rates start to rise. Thus I am warning that the inflow is likely to be found to be short-term rather than long-term investors.

Question of the Week:

What new approaches have you adapted to?

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Four Investment Traps to be Avoided1. Asset Allocation 2. GDP & Unemployment Statistics 3. Co-Investor Risks 4. Statistical Record vs. People

Introduction

In an imperfect world I am always studying to see what I can learn that will help my clients to make smarter decisions. As an analyst I have never been satisfied with any given number as a complete summation of past or present events. In this search I often question the perceived accepted knowledge. Often I find the summary is either incomplete or wrong in the terms of usefulness for future decision making. This blog post deals with some of the generally accepted views.

Asset Allocation

As we all are very much aware, investment performance has left a lot to be desired recently. In preparation for an upcoming client discussion I was considering some managers of funds that put a great deal of faith in allocating portions of their portfolios to different asset classes- equity, fixed income and cash and whether their decisions led to better investment results. One of the fortunate elements of my investment practice is that I have easy access to my old firm’s data. Lipper, Inc., a ThomsonReuters company has produced a computer service known as Lipper for Investment Management. With some help, I asked to see the investment performance of Multi-asset mutual funds for the one year period ending January 31^st, 2016. I compared the results with the proportion of each portfolio in the three main asset classes. The universe contained 433 funds. Some of these funds were the old Balanced fund type, some were Target Date Funds either with fixed or managed allocations; others were flexible funds that regularly used the three asset classes. Further I focused on the top quintile in each sort of performance and asset classes. Thus to be in the top quintile a fund had to be in a select group of 86 funds. Over this particular period the universe on average produced a small single digit loss. The single best fund was up + 3.14%.

One would have thought that the funds that had the highest portion of their portfolios in cash would have done the best in view of the general market decline. Only 21 out of 86 of these funds were in the top performance quintile. Only 32 funds with the largest commitment to fixed income also were in the top performance quintile and finally 55 of the equity funds were in the group that showed the best results.

My working conclusion, assuming that this specific one year time period is representative of some future periods, is that while asset allocation can help performance it is less important than selection of individual securities. In the case of Lipper Advisory, as a manager of portfolios invested in funds, the individual selection of funds can be more important than sole reliance on asset allocation. (As this is a somewhat contentious opinion, I look forward to hearing from our subscribers with their views.)

GDP & Unemployment Statistics

Market pundits as well as politicians spout GDP and unemployment numbers as if they are accurate and meaningful. To me they are not to be used for decisions but as indicators as to what other people think who don’t spend time with people in the marketplaces of commerce and finance. It is these people as decision makers of both small things as well as large that affect the real world. That is why markets often move differently than the perceived numbers. While not as bad as the Argentine inflation numbers, which the new government is addressing so all can understand what is really happening; the US statistical budget has been starved for more than twenty years on an inflation-adjusted basis. Part of the problem with most countries’ GDP data is the failure to recognize the unreported numbers. One clue in the US and the Eurozone is that the fastest growing portion of both currencies is in large denomination bills, 100s and 1000s. You can guess who needs these and what they do with them. Further in the US there are at least six different measures of unemployment. If one takes the most severe and subtracts that from those employed the proportion of the population is indeed still large. Some might even suggest that these two factors (the under-reporting of GDP and the most severe unemployment) could be connected.

From my standpoint I do not put much reliance on the government produced numbers. I find it interesting that when the Presidents of the local Federal Reserve Banks get together they are questioned as to what have they learned from their interfaces with their local communities. Investors and portfolio managers do the same thing. Thus, my suggestion is to follow the markets for the best near-term feel as to direction.

Co-Investor Risk

Too many investors, including professional investors, focus on the risks of the issuer of the securities they own or are considering. To me there is almost always a bigger set of risks. The risk of my co-venturers in the security is the bigger risk. If enough of them want out immediately before I want to exit the security, their selling can damage my terminal price.  The current prices of financial securities are a good example. The MSCI Europe Financials index through February 11^th is down ‑32%, the KBW Bank Index is also down ‑19% (26% since July) with the S&P 500 only down ‑8.8%. While there are some more non-performing loans in Europe, particularly in Italy, most Bank analysts believe the majority of banks are in better shape than when the last crisis hit. I believe the reason for the materially larger decline in bank securities is the fact that 45.9% of the oil-related Sovereign Wealth Funds were invested in financials. By the way, perhaps I am the only one that got nervous when we were told that Jamie Dimon bought 500,000 shares of JP Morgan Chase^* stock on Thursday. This action reminded me of the quote from Mr. JP Morgan in 1929 that he and his son were buying. In the earlier case it worked for awhile but had no lasting stock price benefit. We will see what is the impact of Jamie’s purchase.

*Held in a personal account.

Statistical Records vs. People

There were lots of lessons from last weekend’s Super Bowl. There was no doubt that on the surface the Carolina team not only had a better record as well as a younger more athletic star quarterback, but they lost in a not too close game to the Denver team driven by a few very aggressive defenders who forced the supposedly better team to make mistakes. This reminds me that at times and under appropriate circumstances we select to invest with managers who we think are good and determined over those that have better records. Sometimes statistics can lead to the wrong decisions. Currently in the stock tables General Motors’ price/earnings ratio is listed at 5.5 times. This is historically cheap and therefore to some, attractive. We don’t follow the stock, but I wonder whether looking forward, the market is saying that the stock is selling more like 15 times or similar to the overall market or perhaps higher because the long-term outlook is for materially lower than recently reported earnings.

PS:

I am writing this blog post on Sunday evening, watching Bloomberg Television over my shoulder and seeing the Chinese-related markets are opening down even though their currencies strengthened during the Lunar New Year holiday.

I will be in my office on Monday.    

____________

Comment or email me a question at: mikelipper@gmail.com.

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2016

A. Michael Lipper, CFA,
All Rights Reserved.
Contact author for limited redistribution permission.