News & Reactions - Weekly Blog # 833

 

         

Mike Lipper’s Monday Morning Musings

 

News & Reactions

 

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

   

       

 

Current Picture

For most purposes, the single best measure of the US stock market is the Standard & Poor’s 500 Index. After four weeks of decline, year-to-date through Friday the SPX has retreated 5.94% from its high, although it is still up 5.46% from its low year-to-date. So far, it has given back more than half of its gains for 2024. For the same period the Dow Jones Industrial Average (DJIA) has 15 stocks rising and 15 falling. Probably more significantly, only 6 of 20 Dow Jones Transportation Index stocks have risen. Even more significant, only a single market index rose out of the 32 domestic and international stock market indices that S&P Dow Jones tracks weekly. Expanding the universe to include commodities, currencies, and index funds, only 26% rose this week.

 

For those who wish secondary inputs, the following facts may be of interest:

1. The bullish portion of the weekly AAII sample survey is at 38.3%. A few weeks ago, it briefly reached over 50%. (Market analysts have labeled the AAII readings a contrarian indicator, believing the index represents retail investors who are always wrong.) That is not true! While retail investors are often believed to be wrong at turning points or late to a change, they have a reasonably good long-term performance record. In this case the over 50% reading was achieved in a quick run up, which subsequently dropped to its current 38% reading. This is not far from the mathematical neutral of 33% for each of the three sub-indices. On a long-term basis they may well be correct.
2. The only large geographic region showing growth in the number of listed companies is Asia. Thus, it is somewhat surprising that both Morgan Stanley and HSBC are laying off Asian investment bankers. These are smart people.
3. Residential insurance is absent from the normal inflation calculation. While it is of no significance for renters who have seen no important increase since 2018. Homeowners over the same period have seen their insurance costs go up over 50%. (I wonder how many other omissions there are in government data,)
4. Almost all attention in the forthcoming election has been focused on the top of the ticket. To me this is unwise. Whichever candidate sits in the White House in January will be a lame duck. This President cannot help members of Congress get re-elected in 2026, 2028, and 2030. There is a reasonable chance many voters will not vote this year due to the presidential candidates. To the extent this is the case, the missing voters will come from the center of their respective parties. This will allow the fringe elements in both parties to get more power to shape congressional committees.

 

China Impacts & Questions

Whether the US likes it or not, China is becoming the nation that will impact world trade and growth. In the first quarter of 2024 China’s GDP grew 5.3%, while US GDP grew 4.6%. Something curious happened with some of the Chinese numbers. Industrial production gained +6.1% while prices fell -2.7%. We know that China is selling scrap copper and other strategic products to Russia. (This should cast some doubt on Chinese statistics and their meaning.)

 

Long-Term Considerations

The Managing Director of the International Monetary Fund (IMF) is concerned that growth in the twenty's decade will be “tepid “. Jaime Dimon, CEO of JP Morgan Chase (*), has questioned the general belief that petroleum usage will peak in 2030.

(*) A position held in personal accounts.

 

The standard M&A game is getting more imaginative, at least in the mutual fund management company arena. Amundi, the French investment manager, is selling its American fund assets to Victory Capital for a minority interest in Victory Capital. What made this deal attractive to both participants is that each gained access to the others distribution functions in their home markets, negating the need to build an independent administrative base.

 

The Managing Director of the IMF is concerned about global growth, referring to this decade as the “tepid twenties”. Her concern about growth is partially based on the low level of productivity in much of the world. I share her view, particularly focusing on the US. If you break apart the productivity gain between financial and labor, I suspect labor’s contribution would be quite low. My guess is excessive regulation and less than useful education is holding us back.

 

A recent study shows that interest in the current election is probably at a low point for youths, with only 32% of eligible youths showing any interest in the election. In 2020 it was 56% and 2008 it was 67%. Within two generations these non-voters will be in control, which happens to be when current retirement capital will be feeding some of the current beneficiaries. GOOD LUCK TO ALL.

 

Any Thoughts?

 

 

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An Informative Week with Many Questions - Weekly Blog # 759

Mike Lipper’s Monday Morning Musings

An Informative Week with Many Questions

 

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

                   

 

 

CPI Thursday Morning Pivot or Rotation? 

The readings for the Consumer Price Index and its components were announced before the market opened on Thursday. They were not as high as many expected and market participants treated the less bad news as good news. Many chose to believe the less bad news would embolden the Fed to reduce the size of expected interest rate increases. In effect, the Fed was expected to “pivot”, messaging the market that inflationary increases would be reduced. Their enthusiastic response to the gap opening of the market was not narrowed on either Thursday or Friday.  

 

Market analysts believe that price gaps must be closed before the market can move in the direction of the gap. Most of the time this is the case, but not always. It may take a while. 

 

Market pivots tend to be infrequent, and partially reversed quickly. They can have limited long-term predicative value. However, they can be an early identifier of a meaningful rotation. In this case, the odds seem to favor this pivot not being a significant rotational change. My thinking is based on two inputs. 

 

1.  The mid-term election was largely motivated by a vote against the other side’s leaders and not by a vote in favor of positive growth strategies. Both parties have leadership problems. The Democrats have no fresh leadership with a significant following. The Republicans in some cases did not field attractive candidates and did not match the opposition’s operational talents. With the House of Representatives in the hands of the Republicans, I expect little in the way of new legislation. Many of the expected Executive Orders will also wind up in court. Stagflation will likely be the result. 

2.  Transactional volume will likely be less than expected in a normal bull market. Numerous brokerage firms, investment advisers, and investment bankers, are cutting back on lower producers or those too well compensated.

 

T. Rowe Price Lessons for Investors 

(The following discussion should not be interpreted as a recommendation. T. Rowe is an old personal holding. I have known its CEOs going back to Mr. Price. The firm is investing its capital on broadening its domestic and international marketing and is also developing new distribution channels. Doing so will take time and money to reach the firm’s desired profitability levels. A topic I can address off-line.)

 

T. Rowe Numbers for the Week ended November 11th

• Opened $103.71, closed $133.34 
• Monday-Wednesday share volume in millions of shares:  1.74, 1.85, 1.86 
• Thursday and Friday share volume: 4.49, 5.55 
• Weekly Price Gains: DJ Asset Managers Average +13.92%, T. Rowe +28.57% 
• Institutional Ownership 77.12 % 
• Top 4 shareholders own 26.62 % 
• Thursday’s gap of 5.48% not closed on Friday 

 

While the company is listed on the NYSE, it is essentially an institutional stock owned in some respect by competitors. The size of the price gap and above average gain demonstrates the lack of liquidity on the upside. I don’t know what the liquidity and potential price gap will be on the downside.  

 

Another hint of the professional market dominating the NASDAQ marketplace were the weekly declines as percentage of shares traded: 21.16% for the NYSE vs. 32.85% for the NASDAQ. 

 

Other Thoughts of the Week 

• The IMF believes 1/3 of the world is in recession 
• 7 out of 10 large battery producers are in China 
• With the 2-year and 30-year US Treasury yields at 4.32% and 4.08% respectively, it suggests the minimum expected return on high grade paper will be required for a long time by investors. Could it also mean that this is the maximum safe distribution from high quality accounts in order to preserve principal? 

 

Should real estate investing be divided between current income production and the conversion profits from changing the nature of the property? 

 

Historically, roughly half of small businesses fail within five years. Isn’t it likely this will increase during a period of stagflation? Small company investing has traditionally produced higher returns when large companies are having problems during a stagnant period. However, there will also be offsetting small-cap losses during the period. 

 

What are Your Thoughts? 

 

 

 

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Mike Lipper's Blog: Are You Getting Value from Numbers? - Weekly Blog # 758

Mike Lipper's Blog: Rarely Found Different Thoughts - Blog # 757

Mike Lipper's Blog: Current and Future Views are Confusing - Weekly blog # 756

 

 

 

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The Top Before the “Big” Top - Weekly Blog # 567

Mike Lipper’s Monday Morning Musings

The Top Before the “Big” Top

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

                 

                

The one certainty about markets is their rise to tops and fall to bottoms. With this knowledge market analysts have developed many techniques to identify extreme movements, hoping to spot the appropriate time to reverse course and increase the chance of avoiding large losses or improve the chance of capturing large gains. Market analysts have probably used price charts since the beginning of organized markets in the ancient world. One of the charts that has a good record of predicting future movements is called a Head & Shoulders pattern. (No statistical or other measure is 100% successful over time. Being correct roughly 2/3rds of the time produces satisfactory results and the Head & Shoulders pattern generally does that.)

A price chart is produced for stocks each trading day in The Wall Street Journal, covering each of the three major stock indices: Dow Jones Industrial Average, Standard & Poor’s 500, and the NASDAQ Composite. The three generally move in the same direction, but at different speeds. For the past couple of weeks, the three have produced the same rounding top chart pattern seen during past tops. The critical task is weather to take action based on these patterns or ignore them. I wonder if this is a sign of an important reversal, as the reversal pattern shows three distinct top formations. 

Since the current market is down a bit from the former 2018 highs, a head is in place. Combine this with the relatively brief rounding tops mentioned and this pattern is predicting the end of the ten-year bull market that we have enjoyed for so long. A normal reversal is to approximately give up between 1/3 to 1/2 of the prior gain. (If I knew for sure, each of you would be invited on my personal Boeing 747 on the way to a voyage on my battleship sized yacht. But I don’t know.)

There is a second possibility, that the pattern of the last couple weeks is a possible first shoulder to a new high above the 2018 level, with a more distant final shoulder before a major decline. The current absence of “irrational exuberance” for stocks gives me some hope for the second possibility.

Cautionary Signs for Short-Term Investors

In general, commodity prices have been falling for more than a year since they completed their own bull market. While governments and central banks have attempted drive up growth and the rate of inflation. The continuing abnormal flows into fixed income and credit funds by both individual and institutional investors, at a time when the long-term outlook calls for rising interest rates, suggests that the new buyers are either naive or believe that they have superior trading skills in an increasingly illiquid market. Finally, there is the performance of mutual fund averages through last Thursday night, showing those with year to date gains in excess of 15%: 

China Region Funds       +17.75%

Energy MLP Funds         +16.22%

Energy Funds             +15.98%

Small-Cap Growth Funds   +15.23%

Mid-Cap Growth Funds     +15.05% 

I suggest that those funds currently showing year-to-date gains of +15% are speculative and should be traded out quickly in a decline. However, if investors believe they have these trading skills, the fund categories may be appropriate for short-term focused portfolios.

Thoughts for Long-Term Investors

While short-term investors dominate trading, long-term investors own the bulk of equities around the world. For the US taxable investor, the last ten-years has fattened their prior gains. This raises a question for those seeking to leave a legacy based on a stepped-up basis, without paying capital gains tax, is it better to take the valuation now and pay capital gains tax or the alternative valuation as of the date of death? Even with a major market decline, beneficiaries will inherit more than they would have previously. Institutional Investors concerned with the use of capital for multiple generations could stay invested as some of the present holdings may serve them very well.

MOHAMED A. EL-ERIAN, chief economic advisor at Allianz, and formerly with PIMCO, Harvard Management and the IMF, has published a piece criticizing economists, particularly those within governments, for their reliance on mathematical models without using behavioral science and game theory. Markets often seem to be better equipped than economists in predicting future trends. 

There appears to be some help on the way, the Bank of England is publishing a fan chart of possible future directions in their studies. The Congressional Budget Office (CBO) is already shows a fan chart where 2/3rds of the possible outlooks lie. The CBO study predicts that the US government deficit will rise by about 50% as a percent of GDP in 2019. This could be a low estimate, as both political parties are big spenders. I suspect the next Democrat administration will easily outspend the current occupant in the White House. (This is one of the reasons to bet that inflation will rise.)

History Suggests A Brighter Future

After long periods of stagnation, beyond the world of numbers, forces have saved various societies from their foolish management. The Dark Ages in Europe effectively ended with the discovery and importation of Latin American gold. After years of war spending in 19th century Europe the harnessing of steam power brought greater prosperity, as did the use of electricity. There is a chance that our world will be both disrupted and advanced through the spread of 5G networks, which will practically reach every person, vehicle, and activity. Within this century the rising education, productivity, and savings coming from South East Asia could be another spur. Finally, the evolution of African resources and its people would produce major benefits to the world economy.

Bottom Line

We are likely to experience reversals and volatility, but also pulsating progress. While a few may have the appropriate insights and trading skills to trade various markets successfully, most won’t be able to do it. Therefore, the best position is to stay in the game at various levels with sound and occasionally good investment managers.     

 

  

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https://mikelipper.blogspot.com/2019/02/lessons-from-warren-buffett-and-italian.html

https://mikelipper.blogspot.com/2019/02/could-biggest-risk-be-confirmation-bias.html

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Are We Entering The Most Risky Phase?

Apparently this quarter’s surge in net flows into equity funds has been identified as sourced from idle cash, not from in my opinion the most risky asset class, bonds.  I would suggest that two other factors need to be considered to get a fuller picture. The first factor was the January surge, led by stock investments from defined contribution plans; i.e., 401(k), 403(b), and 457 plans in addition to bonuses. In some of these cases the employer’s contributions and the bonus money are once a year events. Further, I suspect the level of gross redemptions in 2013 are down somewhat relative to 2012, which would magnify the impact of one of the highest January inflows on record.  

                             

There is no denying that many investors both institutional and individuals have turned more positive to equities, almost on the basis of ‘what doesn’t kill you, makes you stronger.’  With a few exceptions, major stock markets gained in 2012, rather than going down in early 2012 as many had thought. This result is in contrast to 13 years of equities generally going nowhere. Total reinvested return calculations for the last ten years of equity mutual funds does show a 10% compound growth rate mainly through reinvesting distributions into more shares at lower prices. Those that spent their distributions did not get this benefit.

Whatever the reason, we are being asked to become more aggressive with client portfolios. We manage each account for its own needs. In almost all cases we produced double digit returns for 2012 and in some cases were ahead of the equity averages (even though the accounts had somewhat of a balanced nature). In one case our gross performance was above the 20% level. Nevertheless some accounts are asking for even better returns which we would also like to deliver, but the increase in the potential level of risk is uncomfortable.     

The nature of risk

Risk is not what is taught in various schools by academics which should be more accurately described as the variability of returns. Risk is not the volatility of prices from short-term period to period, which may describe the comfortableness of a ride along a trend line compared with some other price series.  Essentially risk is the penalty for being wrong to the extent that it causes the investor or his/her beneficiary to change permanently one of life’s essential goals. For you or I, risk is a potential loss of serious magnitude. For you as an institutional investor, a million dollar decline in your portfolio is a bit distressing but your beneficiaries are not really hurt until the loss may be in eight or nine figures. For others personally, a loss equal the cost of a new car or one or two annual college tuition bills would be painful.        

When to expect large losses?

In typical capital preservation-oriented accounts that are well diversified in uncorrelated assets, large risk of large capital losses come from two sources.

The first is that there is greater correlation of price movements than expected, which is what happened in 2008 where practically everything except Treasuries and a handful of other assets fell, with many funds dropping  20-40% or more.  The other way is to become unbalanced through the exceptional success of a single investment, think of Apple^* or Berkshire Hathaway^* for early investors. Instead of representing say 5% of a portfolio and because of relative appreciation, one position now represents over half of the value of the portfolio. Assume that Apple at the top represented 60% of the portfolio and with the current slide of approximately 40% from the top, the portfolio could be down 24% ($60x.40%= 24%). How could this happen?  Allow me to quote from the esteemed Howard Marks, president of Oaktree Capital: “Things get riskier as they become more highly respected (and thus appreciate). There can be more risk in thinking you know something than in accepting that you don’t.” He further states: “the better returns have been, the less likely they are-all other things being equal to be good in the future.” 

* Owned positions in personal or managed accounts

Nevertheless, we have often heard the advice to sell your losers and let your gains run. To do the opposite has been the curse that has fallen on US and UK managers of funds sold into the Japanese retail market where many Japanese measure risk only by seeing how much the price or net asset value has gone up and then they redeem relatively quickly. This view may be aided by their brokers who are interesting in recycling their money into newer investments. In my opinion, both extremes of holding forever (for which I can be accused), or quickly selling after a sharp rise, can be wrong. The key is that every day one should evaluate both the upside potential and the downside risk of permanent loss. 

What are the increased risks today?

If we choose we can buy into the belief that while this year may be economically challenging, like the IMF we can choose to believe that 2014 will be better than 2013 not only for the US but importantly for Europe. This “happy talk” is increasingly being accepted despite the strong odds that France will join the deteriorating countries who won’t come to grips politically with their problems. The potentially sizeable problems of France could well be too much for the German taxpayers’ willingness to carry. Further, I suspect that any significant solutions to the US deficit problems unless solved in the next six months won’t be meaningfully addressed until after the 2014 congressional elections, when the fundamental composition of both houses could change and the White House will completely focus on its legacy.     

The current Federal Reserve Board believes that they are largely in control of the both the level of interest rates and the relative value of the dollar. I believe that the Fed can be surprised by non-monetary events. For example a pandemic of SARS or similar life-threatening waves that can affect the US directly or indirectly. This weekend’s issues around Cyprus could produce symptoms of much bigger problems. For example, if the Cypriot banks can tax depositors on their euro accounts, won’t other governments under pressure to raise tax revenues at least consider doing the same thing? Possibly the regulated banks will be considered less secure than they were a few weeks ago. The skeptic in me always looks for something below the surface to actions of governments. In this case perhaps one should look beneath the surface literally. Off Cyprus to the north there is believed to be a large undersea gas field that Turkey wants to develop. To the south there are possibly two potential offshore oil/gas fields which people from Cyprus and Israel want to develop, and the Russians would like an Eastern Mediterranean port for five of their ships. (Remember this would not be the first time that these types of issues have driven geopolitics both within and beyond the Middle East. The British government sponsored what was, in effect, British Petroleum’s takeover of the Suez Canal from a failing French firm.) Other potential offshore gas and oil deposits could also produce conflicts and disabling price movements in terms of the disputed Chinese/Japanese islands and possibly a significant discovery off Vietnam. One only needs to look at the deep-water find off Brazil and the opening up of Mexican oil exploration as examples of how ‘surprises’ can cause disruption to the Fed’s neat playbook. 

A small but potentially new player is on the scene: Irrevocable Trusts.

In the aftermath of the year-end changes on US estate taxes, I believe a significant number of new irrevocable trusts were created out of former estate plans to lower the size of the estate taxes. Many of these trusts used the maximum allowed of $5 million per grantor. In many cases these trusts are designed for children/grandchildren, personal foundations or other charities. Since these are non-returnable gifts, quite probably their investment character should change. As long as the money was in the planned estate corpus it may have been invested for capital preservation to make sure that the grantor and spouse will have enough capital and income to meet their expressed needs. As the money is permanently set aside and could have a materially longer if not eternal (dynasty) horizon, some or all of this portfolio will be more aggressively invested in a capital generation mode as distinct from the same dollars in the past invested for capital preservations. 

The buyers who could drive the stock market

The following is pure speculation, perhaps informed speculation. As indicated, investment advisors are being asked to produce higher returns particularly at present low interest rates. Money from the sidelines appears to be coming in. The continuing flow from salary reduction savings plans is augmented by employer contributions, particularly as more defined benefit plans are being tapped in favor of new defined contribution plans. Foreign investors who are becoming increasingly nervous about unfriendly home governments may also, at least temporarily, want to shift money into US traded equities, And finally some of the money comes from new irrevocable trusts.         

My dilemma is that I believe we have entered a phase of heightened risk. When these flows do come in, by definition they will have the effect of increasing risk to our markets. Jumping out of the stock market too soon may cause professional managers to lose their jobs. Waiting too long to reduce positions could lead to substantial loss of capital or real risk. Exit timing is the most difficult part of the investment art.   

How are you going to time some of your exits?

__________________________________

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