“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?

 

 

 

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

Mike Lipper's Blog: After Relief Rally, 3rd Strike or Out? - Weekly Blog # 889

Mike Lipper's Blog: Slow Moving in a Fog - Weekly Blog # 888

Mike Lipper's Blog: Significant Messages: Warren Buffett to Step Down by End of Year, Other Berkshire Insights, and Tariffs won't deliver - Weekly Blog # 887

 

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Our Investment Mistake is in Labeling - Weekly Blog # 582

Mike Lipper’s Monday Morning Musings

Our Investment Mistake is in Labeling

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

Mixed Results Change in Focus
While the S&P 500 went to a new record high on Friday, it and the other major stock indices closed down. This is both good and bad news. Investors were not sucked into the market, which confirmed their growing concern for future growth. Currently, many pundits are expecting the same, both in the slower growth of GDP and earnings per share. That is the bad news. The good news is the current lack of enthusiasm for stocks. The reason that this is good news is that often the final phase of a "bull-market" is wild enthusiasm for a subset of the market, which in turn drives the bulk of the market higher. This has not happened-----thus far. Also, more and more analysts are recognizing the deterioration of quality in credit instruments, including CLOs. With these concerns present, now is a good time to examine one's asset allocation. However, this should be done in terms of the intended use of capital, not as is more commonly done by asset class. Purposes are more useful than instruments.

Segmenting a portfolio
We learned long ago that a good way to avoid large losses is to divide our investment efforts into different parts that have different characteristics. The mistake that most make is labeling the diversified parts by asset class e.g. stocks, bonds, real estate and commodities. These labels are too broad and do not suggest their intended portfolio use. Each of the labeled asset classes can be used aggressively or conservatively in terms of intended risk and reward.

The investment spectrum
I suggest that a single spectrum is more useful in building a successful portfolio. This spectrum incorporates the long-term movement of capital, from preservation to appreciation. Every investment is likely to have elements of both capital appreciation and capital preservation; however, at any given time one characteristic is more prominent than the other.

The Prudent Man Rule
If one thinks about the prudent (man) rule that Judge Putnam issued against Harvard in 1830, he was ruling based on what other intelligent men (thus the Prudent Man rule) used in their own affairs. (The judge did not recognize that men, while they may have been the ones transacting, needed to include the desires and wisdom of women in the decision-making process if they wanted a harmonious family life.) What the judge recognized was that different mixes of assets and liabilities produced different results and it was imprudent to rely on a single type of investment.

Betting on an uncertain future
In looking at my personal portfolios of assets, liabilities, and identified responsibilities, I try to group investments in terms of capital appreciation and capital preservation. I do this recognizing my inability to predict the future accurately, as life is full of surprises. This is where my analytical training at the racetrack shapes my thinking. Most money bet on a race is on the horse that appears to have the best chance based on prior success. The problem with this is that the pay-off odds are low and the winnings are insufficient to cover prior losses, unless a great deal more money is bet on the favorite.

While we all celebrate the story of a single-minded inventor betting all on a single invention, we realize that the chance of finding this magic are extremely low. This may well be the cause of my being a contrarian, rather than it being a personality failure. Thus, in my mix of capital responsibilities, my investments are spread out along the expectation line.

Considerations for capital preservation
Judge Putnam did not take into consideration the fluctuating levels of inflation and currency movements we face in the modern world. Capital preservation is not maintaining a specific number of dollars, pounds, euros, or yen, it is maintaining the financial ability to meet a standard of living that is appropriate. Thus, capital preservation stocks and funds are based on expected spending levels. In my own thinking it covers the cost of healthcare and education. Several investments in my capital preservation portfolio are in well managed, secular growing companies, often paying a predictable dividend. Over an investment cycle I expect this portion of the portfolio to do slightly better than average, mainly because it will go down less in periodic down markets.

Considerations for growth
Capital Appreciation stocks and funds are expected to add to our wealth over time and should generate growth above the expenditures inherent in the capital preservation portion of the portfolio. These investment vehicles can only accomplish this mission by entertaining more risk of capital loss. Over a limited number of investment cycles, capital appreciation stocks and funds should lose no more than 50% of their beginning value and should multiply their starting levels two or more times.

When one examines an investment vehicle, I hope you can see the combination of capital appreciation and capital preservation qualities inherent in each investment. Further, I hope your portfolios will have your own appropriate mix of capital.   

How to Apply Capital Allocation
Making precise judgments about the future is probably impossible, but making judgments about the relative growth of capital and volatility is easier. I am sharing my thinking, not as a recommendation to follow, but as an example of how to assign relative probability to your holdings.

In terms of capital appreciation I have identified BYD, a Chinese auto manufacturer which produces the largest number of electric cars in China and has a contract to provide buses in Los Angeles. Furthermore, its chairman is busy working on other transportation products and services. These characteristics and developments, added to the cyclical nature of auto sales, suggest that reported earnings will be erratic for a while. Nevertheless, the possible potential is intriguing. A more diversified approach to capital appreciation would be mutual funds that focus on innovation and discoveries.

In terms of capital preservation, I use Berkshire Hathaway. It has built a portfolio of private companies and publicly traded securities designed for the heirs of Warren Buffet and Charlie Munger, as well as for a considerable number of their shareholders. One could also include the Rothschild Investment Trust, traded in London as a somewhat similar capital preservation vehicle.

Question of the Week:
What have you identified as Capital Appreciation and Capital Preservation vehicles for you and your accounts?
     

     
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/06/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2019/06/on-right-learning-from-left-weekly-blog.html

https://mikelipper.blogspot.com/2019/06/confidence-deteriorating-normally.html



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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.