Expectations: 3rd 20%+ Gain - Stagflation - Weekly Blog # 896

 

 

 

Mike Lipper’s Monday Morning Musings

 

Expectations: 3rd 20%+ Gain - Stagflation

 

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

                             

 

 

 

 

3 ½ Day Trading Week

Normally, in a three and a half-day trading week we expect low volume and muted news of any significance to investors with less intense trading instincts and reduced staff levels. This was not the case this past week. Despite initial unruly Republican Party members in both Congressional houses, the so-called Big Beautiful Bill (BBB) tax and tariff bill passed with few amendments. Significant progress was made on reciprocal tariffs and possible trade barriers. Cease fire agreements in Gaza moved toward peace agreements. One suspects a Russian economic crunch, continued causalities sustained in the homeland, and the US threatening reduced US military aid to Ukraine, could hopefully lead to a reduction in deaths and soon become less of a distraction.

 

Trading Reactions

Led by favorable reactions to the passing of the BBB that were cheered on by The White House, many saw things getting better. These reactions stirred up bullish sentiments resulting in the S&P 500 Index reaching its first high for the year since February. Some even suggested 2025 could be the third +20% gain year in a row, a rare event.

 

Professional analysts and experienced economists are two-handed thinkers who don’t receive the same air or face time that advocates of simple tales do. First, the S&P 500 is a capitalization weighted index with a small number of highly valued stocks recording bigger gains than the average stock. An equally weighted index gained 5% less than the S&P 500. More importantly, at least to me, 9 of the 11 industry sectors in the index underperformed the overall index, with Info Tech and Communications doing better.

 

Economists often turn to the actions of corporate leaders for clues as they feel the stock market is too volatile and occasionally wrong in direction or magnitude. Currently, slightly less than half of publicly traded companies have announced employee layoffs going forward. Considering the cost and time spent getting qualified employees, cutbacks are an expensive strategy companies would like to avoid. Part of their problem is that they can’t find qualified new employees today, which means it is particularly painful to let good ones go. This is particularly true for companies with an aging workforce.

 

The lack of success in finding good new employees while keeping the better aging ones is in my mind not a cyclical problem cured by higher sales levels. It is a secular problem caused by the system we have built, which has failed us by confusing education with schooling. The problem starts in the home, often due to a single adult household, and continues on through early childhood education. The impact is felt all the way through PhD studies, with a system awarding promotions through test taking rather than productivity and intellectual integrity.

 

Historical Lessons

Perhaps we can learn from the past. With that thought in mind I recommend reading this week’s Barron’s article titled “The Coming Stagflation Won’t Feel Like the 70’s” by Joseph Brusuelas. I believe there is another parallel that should be considered, the US with an activist President and an accommodating Congress. Both the current occupant of The White House and FDR came into office seeking to make fundamental changes, but both ran into opposition from the courts. FDR took a recession and turned it into a depression, not by choice but in part due to the impact of stagflation. I do not necessarily agree with Joseph Brusuelas’ statistical projections.

 

What do you Think?      

 

 

 

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Recognizing Change as it Happens - Weekly Blog # 876

 

 

 

Mike Lipper’s Monday Morning Musings

 

Recognizing Change as it Happens

 

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

 

 

 

Perspective is Difficult to Read

When gazing out a window while traveling in a car or a plane the view constantly changes, while the view within the vehicle remains constant, similar to the internal changes we experience while investing. Many of us are aware of both the outer world and our own investment perspective, although we are often unaware of the changes in people next to us. Rarely do we focus on factors impacting our own thinking during our travels.

 

Now may be a good time to review what is happening to those close to us, and even more importantly to ourselves. The following list of items crossed my consciousness this week, causing me to consider changes to our investments. In no particular order:

 

1. While I am aware of the US stock market trading volume growing, the rate of change between the 2 stock markets is telling. Over the last 12 months trading volume on the NYSE has grown +8.03%, while the NASDAQ has grown +57.39%. This indicates that there are two very separate markets. This was confirmed by Thompson Reuters’*, an old Canadian/British firm, through their actions this week. They moved their US listing to the “junior” exchange, which they identified as the home of technology companies.
2. The AAII sample survey had only 28.4% of their participants being bullish for the next 6 months, while 47.3% were bearish.
3. The Economic Cycle Research Institute (ECRI) industrial price index was up +6.44% over the past 12 months.
4. The Chinese marriage rate has dropped -20.5%.
5. JP Morgan Chase* announced layoffs for next year.
6. International Mutual Funds were the best performing group this week for the first time in a long time, led by large-cap growth funds.
7. The Financial Times is asking how big Walmart* can get.
8.  Until we actually see the final legislation and/or a court ruling, one wonders how the US will be governed. The US executive branch of government is in the courts for changes they’d like to make, after legal challenges.

I wonder how much longer the four international political leaders (Putin, Xi, Trump, and Moodi) will remain in power.

(* Owned in client or personal accounts.)

 

We are at a period in history where multiple large changes are occurring somewhat simultaneously, with significant consequences for winners and losers. Time is a scarce resource and that creates a sense of urgency among the participants. The following events bear close scrutiny as the outcome will be consequential for all.

• Change in US government – The power dynamic is being challenged in Washington DC and the courts, with a clear understanding that power could revert to the old order after the mid-term elections. So, Republicans recognize that change must be accomplished within the next two years. If the Republicans are successful, the country will likely see smaller government with some power ceded to the states. Smaller government should come with smaller costs, a plus for the national debt situation.
• Global government dynamics – Many governments around the world are grappling with similar ideological dynamics as those seen in the USA and are nervous about what might come next. This was on full display at the Munich Security Conference this week. The potential for trade wars could intensify significantly.
• Two wars have the potential to conclude this year, Gaza and Ukraine. Not all are likely to be happy with the outcome. Nor will there be unanimity among those shepherding the negotiation. Rebuilding will be costly in both locations, with no clear indication of who will pay and what deals will be struck to compensate those investing the money.
• Significant technological changes are likely in the next few years, with AI, robotics, and automation at the center of these changes. There will likely be big losers and winners, where the first mover advantage could be quite significant.
• An energy renaissance is likely, as the new technology driven future requires substantially more power than what it is replacing. The green revolution will not likely provide adequate solutions for the energy shortages. Natural gas and nuclear power seem to be the likeliest winners, as they provide the most consistent baseloads and the smallest CO2 emissions.    

Each of these bullet points has the potential to be disruptive. Having them all occur at roughly the same time will make for a challenging investment environment. While traders may be able to trade successfully, the odds favoring investing are declining for the next several years.

 

I would like to hear contrary views.

 

 

 

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Get Ready to Pay For the Price of Wisdom

Introduction

August is the time that many parents and grandparents send tuitions and other payments to institutions of supposedly higher learning. We do this with the hope that our children and grandchildren will learn useful life lessons. (We recognize that so-called life lessons as taught by ivory tower academics will quickly evaporate, leaving a residue of how to spot valuable lessons in the “real world”.) But our young are not the only ones who should be prepared to enter a period of intense learning where they will be challenged. I suggest that every investor in the world is about to enter such a phase, whether we like it or not.

In a recent well written interview with the leaders of an important private-equity firm that was coming back from some serious mistakes the following points were made:

          “We had great successes which led to great mistakes.”

          “Ultimately mistakes are a bridge to wisdom.”

We are rushing up to such a bridge. We need to recognize the bridge is a toll road. A payment will be extracted from us whether or not we want to get to the other side. Further, we probably won’t be able to turn around and return to an investment period characterized as complacent, at least on the surface.

Still, calm waters

For the sailors among us until Friday the stock markets looked to be becalmed. This was in spite of Ukraine, Gaza, and Iraq battles, and economic data being published that is contrary to many learned estimates. Most so-called experts have been expecting interest rates to rise. However, by Friday 15 and 30 year mortgages, plus jumbo mortgages and rates on car loans all declined on a week to week basis. Reinforcing a feeling that the banks while fighting for market share are anxious to make retail loans, the average rate for money market deposit accounts (MMDA) also fell a bit. Many investors also do not seem to be concerned about the slowdown of the engine of Europe that is Germany.

I believe their attitude is that this is entirely due to sanctions on Russian trade. This is a concern to me on two counts. First, I believe the slowdown is being caused by deteriorating business conditions on the Continent;  Italy is already in recession and France won’t be far behind. The second count is the parallel with the month in between the assassination of the Archduke Franz Ferdinand and the first declaration of war to begin WWI. For my non-history student readers, the declaration was by Austria against Serbia.

A number of my friends who are believers in the value of charts are as usual worried. They question whether the declines we already have seen are the early stages of a standard correction to the remarkable results we have experienced in the price performance of many stocks led by small caps in general and numerous social media and biotech stocks.

I suspect we will at some point, not of our choosing, be buffeted by violent winds that will drive us back on to land again or out to sea to be exposed to greater danger.

The ultimate “Head Feint”

For my readers not familiar with American professional football^*, when the teams line up on the scrimmage line some players move their heads in what they hope will either make the opposing team think they know where the play is going to go or cause an opponent prematurely jump the line and draw a penalty. The next move in stock and bond prices may very well be such a head feint that will get many investors expecting a move in one direction, when the more significant move is in the opposite direction.

^* I have served as an investment advisor to the National Football League and the NFL Players Association for the past 20 years.

As my regular subscribers have learned I am very concerned that we could be due to have a material decline, possibly of the 50% variety. Based on the past, I believe to get that terrible decline we will need to see a sharp price rise in enough securities beforehand to suck all or almost all of the sidelined cash.

Wise lessons 

Wise lessons for forthcoming markets:

1.  Assume that each of us individually, corporately and politically will make mistakes. The key is to recognize the mistakes quickly.

2.  As skilled traders we may want to ride the momentum, but as investors, we should practice investing against the headlines and pundits.

3.  Recalculate your spending reserves. In our time span portfolio approach I advocate determining the rate of expenditures over the next two years including the potential of some negative surprises. I believe the discipline of a spending rate determination should be based on current facts not an overall budget calculation and not a copy of last year’s spending.

4.  Most investors talk long-term, but recognize that investment committees, both formal and informal may change over a five year period. Thus the replenishment portfolio to recapitalize the operating fund should expect a significant decline in the market in the next five years. (Readers of these posts should understand that it is the tyranny of these changing investment committees that I focus most of my commentary.

5.  Those investment portfolios that can expect to meet institutional or family needs beyond five years but within the expected lifespan of the bulk of the investment committee should develop target prices of securities that would make them attractive. These can be the existing names or new ones. For those who have high confidence in their analytical skills, earnings per share, gross margins or return on invested capital or similar measures can be used as triggers rather than prices. Warren Buffett looks for periodic price slumps to buy at favorable prices as did Sir John Templeton.

6.  For those who are managing their own or institutional money to meet the needs of future generations, the changes in market structure which accompany major stock price declines and other disruptive events create opportunities to find new champions which can produce spectacular value. If a number of these can be bought in the dark days, losses should be relatively small as a percent of the overall portfolio and the winners could be very meaningful.

7.  Never stop learning and looking for wisdom without being defensive of what “we know” that can prove to be it is just not so.

 

Please share with me what lessons you have learned and particularly those that you have now discarded.

__________    

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I Suspect and I Accuse

Introduction

Today’s post is a double header with the first part focusing on thoughts as to the current markets and the second on longer-term issues that should be considered for investment policy considerations.

I suspect a “Melt-Up”

In last week’s post I discussed three possible directions for the current market, “melt-up, muddle along, and decline.” At this juncture, for at least awhile, the apparent path of least resistance is to go up in price.

Positives

There is a belief that surviving a problem that doesn’t kill you makes you stronger.  Most global stock markets did not fall on the two threats to geo-political peace last week; the downing of the Malaysian airliner over Eastern Ukraine and the beginnings of the Gaza strip ground attack. If the markets did not fall, then some believe the path of least resistance is for stock prices to rise. (Remember it took one month from the assassination of the Austrian Archduke and when World War I was declared on the European continent.)

Often when low to intermediate credits rise in price (decline in yields) relative to high quality paper, it is favorable to stock prices. Each week Barron’s publishes a confidence index based on this relationship. Normally it is quite stable. For the week that just ended the current reading was 69.9% vs. over 74% one year earlier. English translation is “risk-on.”

Because so many analysts and portfolio managers are relatively new to the business they tend to look at past history in terms of calendar movement of the Standard & Poor’s 500 index. They do not recognize that in an average year since 1980, according to JP Morgan Chase there is a 14.4% decline from peak to bottom. I am particularly sensitive to 1987 when for the year the S&P 500 index was up slightly but there was a  -34% peak to trough decline thru the year, and much worse in the average stock. In our analysis of mutual funds for our clients we pay particular attention to the declines of- 49% and -19% in 2008 and 2011 respectively. But who cares, the market always come back.

The consulting community and institutional “gate keepers” pay attention to ranked performance particularly of short periods. We have maintained for some time there is little in the way of persistency of good performance from quarter to quarter and even for one year and particularly for three years. S&P recently did a study of top first quarter performers for the first quarter of 2012. They compared these winners to the top 25% winners for the similar quarter two years later. They found that only 3.78% of the funds repeated in the top quartile. What were even worse were the large capitalization funds where only 1.9% repeated. Remember large cap stocks have more analysts following them than smaller companies. What this suggests is that the market may well be shifting to favor short-term momentum winners which would be leaders in a sharply rising market.

Ignoring what you don’t like

If you can ignore facts and views that are cautious, one can become more bullish quite quickly. Some of the subjects that investors seem to be ignoring are: 

1.      Private Equity Funds are selling their holdings at high valuations.

2.      Lust for yield is forcing investors into less conventional-higher risk paper.

3.      People seem to forget that most Merger & Acquisition deals work out poorly for continuing investors. That it took so long for Steve Forbes to find an acquirer for the majority of his company shows that the private equity buyers are more cautious now than the public investors.

4.      Interest rates are rising each week, for example: 15 and 30 year mortgage rates, new car loan rates and the banks’ cost of deposits (MMDA). At the same time numerous banks are reporting, as forecast, lower quarterly earnings and are looking to new markets to replace their crunched earnings power, e.g. PNC. This is occurring in a period when people are saving less and the spreads between high and low credit quality is narrowing.

5.      Many US investors are turning to Europe to find good investments. This surge in demand has led to a 102% increase in Western Europe High Yield issuance in the first half of the year. (Anytime there is an increase in low credit quality issuance I wonder when we will see a meaningful uptick in defaults.)

I Accuse

This is the famous title of an open letter to the President of France by Emile Zola about the “Dreyfus Affair” which eventually led to Captain Dreyfus being exonerated and a public recognition of societal biases in France. In a far less dramatic context I accuse my fellow members of the global financial community of complacency. While we all see any number of troubling events, most do not change or plan to change our investment positions. In effect many have elected to play “the greater fool theory” card in an undisciplined way.  A few of the things that should cause at least some of us to begin to shift away from risk of loss of capital are as follows in no particular order:

The sale of the Russell indexes to the London Stock Exchange opens more questions as to the future value of index production.

Internally both the US and Canadian central banks are looking for methods of improving their research in private recognition that they have not been very good.

We are seeing considerable “flight capital” movements. In the US the net sales of international funds is increasing as domestic oriented funds are in slow growth or net redemptions. In Europe we are seeing that the bulk of the long-term fund sales are not in funds from cross-border managers and are often going into investments outside of their domestic market.

Some very visible investors have made the following statements:

Carl Icahn:“This is the time to be cautious.”  

David Kotok: of the esteemed Cumberland Advisors indicates that tapering is now going to be tightening.

Kathleen Gaffney: Well-known bond fund manager now of Eaton Vance^* noted that traditional bonds have interest rate, credit and liquidity risks which is shoving us into unconventional paper.

*Stock owned by me personally and/or the private financial services fund I manage

An example of a real concern of mine is the discussions of an informal group of retirees, semi-retired and active portfolio managers, analysts both fundamental and technical, and an experienced institutional salesman. In periodic meetings, from my viewpoint, too much of this group’s discussion is on the issues of the day (often political) and not enough about individual securities and portfolios.

This group may well be a microcosm of the investment community trying to get the last high price for what they own while wringing their hands as to problems facing the investment world.  Within my own responsibilities I have only recently started to sell long held positions, but still are very much an investor in equity funds and some individual stocks, mostly in the global financial services arena.

What we should be doing if the melt up gathers momentum is to place sell orders at various different levels so that we maintain our survival capital for the next major bull market, which I expect beyond the next five years.

To my readers at Citywire Global

Thanks to my City, UK and European readers for once again making my blog one of your top choices.  Last week’s post was listed as Number One of the five most read stories on Citywire Global. I appreciate your readership.

Question of the Week: Do you have any specific plans to liquidate some of your “at risk” assets? 

__________________

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All Rights Reserved.
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