Large Opportunities and Risks - Weekly Blog # 626

Mike Lipper’s Monday Morning Musings

Large Opportunities and Risks

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

Current Picture
Normally the US stock market moves at a pedestrian pace, with annual moves of about 10% (7% to 12%). We have just completed a two-month period that by statistical definition includes the fastest “bear market” in history and a recovery that would qualify as a one month “bull market”. There are some signs the recovery has likely ended, with a rounding or flat top for the three major stock indices. Furthermore, the lack of confirmation by the VIX index and the advance/decline line is casting doubt on the direction of the market. Thus, we have probably entered a confusing period, which until it is resolved will lead to lower volume. It offers an opportunity to reposition for a significantly lower market based on deteriorating economics and politics, as well as an  opportunity to buy into stocks that will be viewed as great bargains in the years ahead.

I am a somewhat risk-aware contrarian long-term investor and advisor. Both the Bulls and Bears could be right. For long-term investors, the bulls have an eventual chance to multiply their capital many times over, whereas unleveraged bears could preserve a portion of their capital. Careful bulls amass more capital over time than bears, although some bears have produced exciting short-term returns.

This dichotomy produced the first modern hedge fund, which was housed in the same 74 Trinity Place building in which I spent 25 years. A.W. Jones, a former magazine writer, came up with the concept of always being 50% long and 50% short. This produced good but not spectacular results over the years, often due to declining less in down markets. Unfortunately, he moved out of the building before we established our office there, but I did study his results. From that study and analyzing the success of a number of mutual fund and other managers, I concluded that long-term investing on the long side produced satisfactory returns. My lifetime’s work leads me to briefly outline the case for increasing equity investments now, although I should first clear up the one reason media pundits have led the investing public into a confused state.

What is in a name?
Our ability to name something or someone is critical to organizing our internal filing system, otherwise called memory. But it is also the source of much confusion if the name is not specific enough, such as with a company’s name. A name can mean different things to actual or potential customers, employees, competitors, lenders, and various types of owners. Much like blind people feeling different parts of an elephant.

Some of the abovementioned people are interested in what the company can do for them today and that becomes the company’s image, although it’s quite different for those who own the company’s debt or equity. They are vitally interested in the future securities price of what they own or are contemplating buying and need to guess the price of the securities at future dates of importance to them. The price will be determined by the current owners selling for some unidentified reason, while potential buyers compare similar investment opportunities. Today, most companies are experiencing falling sales and increasing prices, so things look temporarily bad. However, the securities buyer is looking at pent-up demand, which could return to 2019 levels, more or less.

The Optimistic Case
As is often the case, buying largely rests on demand in the short, intermediate and long-term. In the short-term, the $4 trillion in Money Market funds is earning next to nothing relative the real inflation being generated by the COVID-19 stimulus. At Bank of America (Merrill Lynch), 14 % of the average account is allocated to cash. In the intermediate term, when both businesses and other consumers get more comfortable, pent-up demand will generate sales of products and services.

In the long term, the main purpose of most money in institutional and individual accounts is to create future payments for specific retirements and/or legacies. If one amalgamates the retained earnings from 2018 through the present time, my guess is that in general it did not earn an actuarial rate of return sufficient to meet future payout desires. As my Grandfather’s friend Bernard Baruch explained to congress, the Latin derivation of the word speculate is to see into the future. I expect to see changes in how we live and think about the future coming from demographic trends, the march of technology, and the impetus from the current Coronavirus and future COVID plagues. As a global society we will be paying more for longer and more expensive retirements, particularly in the end.

An example of a little noticed change with larger implications is the following small notice on page 2 of The Wall Street Journal. 

“Notice to readers, Wall Street Journal staff members are
   working remotely during the pandemic. For the
   foreseeable future, please send reader comments only by
   email or phone using the contacts below, not U.S. Mail.”   

Considering President Trump wants the Postal Service to charge much more for packages, while rural members of Congress remain unwilling to change the schedule for mail delivery, future communications from various governments are likely to change. We are already seeing a smaller quantity of mail, which is not altogether negative, but is a lost sales opportunity for some.

The biggest long-term change I see is the possible reduction in our real estate footprint. Not only in our homes, but hospitals, schools/universities, and entertainment locations. I became more convinced of this threat when I read an article on the latest Gallup Poll survey, where individuals favored real estate over securities as an investment. As a contrarian I hope they are right but think their view will change as real estate becomes more difficult to sell, due in part to mortgage rates rising and state/local taxes going up.

What to Buy?
As usual, there are investment performance arenas from which to choose current winners and laggards. One advantage our clients have is that I look over the performance of all US and over 26,000 offshore funds each week. In the latest week, measuring from March 23rd which I am using as a bottom, the three leading mutual fund peer group averages were Precious Metals +47.40%, Equity Leverage +46.36%, and Energy MLP +43.16%. These are narrow-based funds enjoying a large recovery, which should probably not be a large part of a long-term mutual fund portfolio. The best performing diversified equity funds for the same one-month period were: Mid-Cap Growth +27.14%, Multi-Cap Growth +25.54%, and Large-Cap Growth +25.31%. Clearly, in this recovery growth has been favored in part due to its positions in the health/biotech sector, which gained +30.12%.  What may be significant is that performance leadership is no longer the sole property of large-cap funds, suggesting the overriding need for liquidity is shrinking.

Future performance leaders often come from the bottom of the performance ladder, which in this case are a few well-managed Value funds. However, one needs to be particularly careful looking for Value today. Far too many base their analysis on the spread between book value and price, which was a scholastic task assigned at Columbia University by Professor David Dodd while I was there.

This was a relatively easy job because we had the published financial statements, which had some relevance back then. This was not the way he and his partner Ben Graham (*), at the closed end leveraged Graham Newman fund, produce his great performance. Book value, according to their student Warren Buffett, is today misleading. It is an accounting number based on the historic cost of assets, which can only be changed by impairments, not improvements.

The task in the class I took was to identify companies that should be liquidated, not purchased as a going concern. There are relatively few of these companies today, as they are usually prey to private funds who specialize in this art form. There are however a reasonable number of companies whose financial statements do not fully reflect their improving value in the right hands. Careful and patient analysis can uncover their true value, the trick is identifying what or who will recognize their true value and change investor’s perceptions.

Conclusion:
Successful investing is much more an art form than a quantitative exercise. It requires patience and luck to make one’s investments profitable. 


(*) I am the recipient of the New York Society of Securities Analysts Benjamin Graham award



Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/04/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/04/long-term-investors-mistakes-ahead.html

https://mikelipper.blogspot.com/2020/04/time-to-get-out-of-foxhole-weekly-blog.html



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A. Michael Lipper, CFA
All rights reserved
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The Actively Worrying Class/Passively Investing Holders - Weekly Blog # 569

Mike Lipper’s Monday Morning Musings

The Actively Worrying Class/Passively Investing Holders

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

       

                                  

In many sporting events and wars the side that talks most often exhausts themselves, or at least is constrained by their public statements. The theoretical wall of worry that bull markets climb is constructed with bricks of displayed worries. Currently, particularly for some this weekend, there is a lot to worry about. The pundits in the media and salespeople are clever annunciators of worries. As both a student of words and investors actions, I have noticed relatively few actions on the part of investors. What follows are two worries linked to two true concerns and one very current display of actions.

I share military service with the two President Bushes (Captain, USMC) and the current President, who had a secondary school military experience. Those military experiences arouse strategic considerations that all too few are paying attention to, some that threaten peace.

China
In the early part of the 20th century there was much written about global geopolitics. The German general staff believed that whoever controlled the landmass of continental Europe and Asia would control the world. US Admiral Mahon believed that whoever controlled the oceans would control the world. These beliefs are still very active in the minds of global leaders and explain much of today’s news.

Some of the investment managers we use have for decades invested in China. They believe the current government does not have territorial ambitions, but economic ambitions to be the respected as an economic leader of the world. They are very anxious to reach this point in order to avoid becoming too old before they become, on a per capita basis, rich. As is often the case, people look back on periods where things were better for them. The ancient silk road brought acknowledgement of the riches of China to the rest of the known world. China was the most advanced country in the world in terms of economics, technology, and culture.

The current Chinese leadership is rebuilding the silk road with the help of its neighbors, a land route for rail and road from China to Europe. In addition, they are equally busy building a series of sea routes and friendly ports through the South China Sea, across the Indian Ocean, and up the coast of Africa into Europe. This week’s Chinese visit was intended to establish closer trade relations between Italy and China. Remember the return of Marco Polo to Italy from China and the enormous wealth a few Italian cities earned from their trade with China. (Many years later Boston generated some of its wealth through the Clipper ship trade with China. Taking care of the wealth of successful sea captains while they were gone for periods often longer than a year was the foundation of a good bit of the trust business controlled by Boston law firms, who had their own money managers.)

I don’t know what the current President learned at the New York Military Academy or at Wharton (University of Pennsylvania), but I can share my views. The current so-called trade war with China is an attempt to modify China’s long-term strategic thinking. The first objective is to insure freedom of naval passage in the South China Sea, through which a great deal of China’s strategic imports must move. Europe is increasing its reliance on Chinese imports to meet its needs, including its technology needs. The future of technological dominance is even more important to President Trump than the naval considerations.

While China can produce low level semi-conductors, they must import the most advanced semi-conductors to meet both their industrial and military needs. These issues will soon play out in the control of space and become the point of maximum disruptive power. Thus, it was not at all surprising that the White House sought to establish a sixth independent military service, a space force. This initiative was defeated on “The Hill” and it will now be incorporated within the Air Force. In my opinion, tariffs were a means to get the Chinese to the table to resolve more strategic questions.

Answers to Productivity
Some of the best scientific and political brains have been struggling with the fact that US productivity appears to be stuck at a low level of about 1% per year. In past periods when the US was growing in the mid-single digits, productivity was growing at similar levels and for awhile reached 7%. There are at least three reasons for the slow growth. The first ties back to my education in the US Marine Corps.

For the most part the Men and women who join The Corps are no different than the general population, they are just trained better. From the very beginning they are trained in leadership, which was why I wanted to be a Marine. My desire to learn leadership skills originated one summer when I was in high school. I had a manual job in a small laboratory where I heard of the lack of leadership in the low and middle management tiers of large US companies.

A survey of US workers states that no more than 30% are engaged in what they are doing on the job. Gallup and others believe that the main fault lies with the immediate supervisor of the workers. Contrasting that with my training as a junior officer in The Corps, we learned that battles and tasks are often won by the leadership of the non-commissioned officers. These corporals and sergeants lead by example, by training, by their own discipline, and by caring for their troops. As officers our job was to support the NCOs and our Marines in any way we could. Those attitudes are not present in the supervisory workforce today. Workers need to be inspired to do their jobs better and help others in the group so that become promotable.

Another way to improve productivity is to see the challenges of automation. There are far too many articles about people being replaced by machines, an issue first raised by the Luddites attacking automation in the spinning mills. Machines are good at repetitive functions but require people to figure out how they should best be used. Like identifying the next steps in the process and how to create the need for new products and services. Perhaps there are unmet needs to re-educate workers and users, both for existing products and services and for those of the future.

A third answer is perhaps the single best way to increase productivity, through better schooling and education. The distinction between the two is that schooling is what you are taught, education is what you learn most often from life experiences outside of school.  We need to have people recognize that everyday experiences can lead to an education. The idea of a workless retirement is no longer relevant for most, as not working leads to increased spending. There is still important and fulfilling work in the charitable sector that is necessary for our society to progress.

After Worrying, Probably Do Nothing
If one looks at the last 3 days of the previous week, one can see reasons for worry. The table below shows the closing prices, price changes, and volume for Moody’s, a stock owned in our financial services fund.

Date    Price Change    % Change    Share Volume    Last Price
3/20       -1.38          -0.77       1,269,927       $177.25
3/21       +4.74          +2.67       1,700,888       $181.99
3/22       -4.10          -2.25         987,175       $177.89

Interest rates generally drive potential opportunities for Moody’s ratings on new bonds and credit instruments. On Tuesday the 19th the Federal Reserve said it was not going to raise rates, suggesting more money could be raised. By the next day some had concerns that the Fed, by not raising rates, was worried that the economy was closer to a recession. The following day sentiment changed again and the market viewed things more positively, leading the stock price to move to a new 2019 high on much better than average volume. Only to be followed by a pull-back on Friday to Thursday close, but with only 58% of Wednesday volume.

One could interpret from this tiny sample that while there are lots of things to worry about, most investors will continue to hold on to their long-term stock investments, at least for the moment. Because of the announcement on the Presidential investigation today, I expect that those with a strong view will react on Monday. My guess is that whatever happens there will be a reversal later in the week.



Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2019/03/long-term-trends-may-not-be-friend.html

https://mikelipper.blogspot.com/2019/03/the-top-before-big-top-weekly-blog-567.html

https://mikelipper.blogspot.com/2019/03/2-speed-vs-2-directions-old-better-than.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 - 2018
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.