Fragments Prior to Fragmentation - Blog 829

 

      

Mike Lipper’s Monday Morning Musings

 

Fragments Prior to Fragmentation

 

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

   

 

 

Historic + Military Learning

Some have said, if you scratch a good security analyst a historian will bleed. If you add in two other variables, learning from military training and exposure to the racetrack, you will understand much of my thinking. In fearing World War III, one should start with the German General Staff study of the American Civil War and the Peace efforts prior to and post WWI. Long periods of relative peace can be achieved most of the time if intelligent leaders continue to plan for economic and military hostilities.

 

Since we don’t know what the future will bring, we should study every fragment of information available and track developments that might lead to dangerous conflicts. Few peacetime leaders are equipped to be successful war leaders, and often they make war inevitable. I believe a lesson from one of the various “war colleges” is that war is another way to conduct political change. Our political leaders increasingly use an “anything goes" approach to cling to power, ignoring the vulnerabilities they are exposing for our adversaries to exploit.   

 

In retrospect, it has become increasingly clear that WWI and WWII were inevitable. The threat of nuclear war and some of our world leadership has held off WWIII, hopefully forever. Due to improvement in tactical nuclear and other weapons, there is greater risk today than in the past. We need to review all fragments as they appear and be watchful of those which could harm us.

 

Dangerous Fragments Past & Present

In the 1920s, the general urban population looked askance at criminal controlled bootlegging but enjoyed the local speakeasies. Today’s version of this attitude is the general disrespect for most members of Congress. Although they continue to support their local representatives, or for the younger set, the local ‘pusher”. We seem reluctant to reform our own process of offering debt forgiveness in the hope of gaining votes. They don’t seem to see these stimulants as bribes, much like the circuses that led to the fall of the Roman empire.  

 

Daily Stock Markets React to Central Banks Words

On Thursday, 27 % of the “Big Board” stocks declined, with 38% falling on the NASDAQ. The next day, 64% of NYSE issues fell, with 63% falling on the NASDAQ. The only difference was many traders finally believed the clues given regarding the possible number of interest rate cuts this year. (They paid no attention to the view that the next rate move by the Fed could be up.) Most of the time investors stay focused on their long-term needs and don’t react to politicians and pundits.

 

Fragmentation Becoming More Popular

On many days more stocks go up than down. This week, 21 of the 28 foreign markets Barron’s tracks rose. However, in the US only the momentum index has gained double digits over the last two months.

 

What is the Remaining Upside Left?

While it is popular for market leaders to mention their gains from the  bottom, the payoff for today’s investor is what is left? Jeremy Grantham, Chair of GMO, has generally held a bearish view but has generated good long-term performance for the funds he supervises. He mentions that if one uses the Shiller P/E, the market is in the top 1% of its history. A more significant observation is that many analysts use both P/E and profit margin, which are linked, so they are double counting. (Profits = Earnings, which is the driver of margins)

 

Today’s Parallels with WWI And WWII

Russia is in fighting a war in Eastern Europe, with Western Europe supporting the locals. The US is in a trade war with China and is constraining trade. Our opposition is getting stronger, although we are having trouble convincing people that they need to fight. This reluctance exposes our current weakness to our adversaries, giving them reason to cheer.

 

The markets generally seem to be ignoring the geopolitical hot spots accumulating around the world. There seems to be a perception that we can ignore these problems as they are occurring in some distant land. However, these problems are now surfacing closer to home and their citizens are increasingly arriving at our borders and making their way into the country. The situation is putting significant strain on resources and budgets, at a time when pet projects are already being funded in the hope of attracting the support of an expectant electorate. This spending is unsustainable in the long-term and creates additional vulnerabilities for our adversaries to exploit.  

 

 

 

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“Things are Seldom What They Seem” - Weekly Blog # 718

 

Mike Lipper’s Monday Morning Musings

“Things are Seldom What They Seem”

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

This is the title of a song by WS Gilbert of Gilbert & Sullivan in the operetta H.M.S. Pinafore. The title seems appropriate to thinking about investing today. In gathering research to reach my conclusion, I excluded positives that led to a bullish conclusion, but not because it’s unlikely. To the contrary, most investors tend to be optimistic, their views are documented by investment and political pundits. Consequently, another similar voice is hardly additive. Seeing potential negatives is not a popular exercise, although it’s useful in bringing balance to one’s views. To be perfectly clear, the vast bulk of my investments are invested in stocks and equity funds for the long-term, even beyond my life. I hope the majority will pay off in total return, comprised of price appreciation and growing dividends. The biggest problem today is that very few investments generate income sufficient to meet reasonable future expenses after inflation and taxes. The inability to meet current and future expenses from dividend and interest payments is a sign of a highly priced market.

Critical International Competition

Our geopolitical discussions are often based on Ukraine or China, with these conflicts placing the Western world at a disadvantage, regardless of our greater wealth. The current administration is playing checkers, where one needs to get up close to the opponent to eliminate one of the opponent’s pieces. The Russian leader appears to be an excellent chess player. The goal in chess is to capture the opposing king, using players that have different capabilities and proximity. Our Chinese competitor believes time is on their side and is building a greater level of self-sufficiency. Both appear to be capable executors of tactics and strategies based on a lifetime of work and success. By comparison, many members of our cabinet and senior staff were chosen based on their identity and political views.

Earlier this week at an investment committee meeting I mentioned that Russia had already accomplished its real mission, sponsoring disunity among European NATO members. Both German and to a lesser extent Italian business leaders wanted to maintain close relations with Russia and China. While I still believe this is the way they play global chess, there is a contrary action on the horizon. One of the main political parties in Sweden, concerned about the fluidity of Russian troop movements, wants to join NATO. With Sweden’s technological strength and good military, it could more than make up for the potential loss of Ukraine. Whether this happens or not, the mere fact that it could, is an example of “things are seldom what they seem”.

Guessing the Future is Difficult

As securities analysts, we used to say the one saving grace of weather forecasters is that they made us look good by comparison. (In terms of weather, I should point out, the less than optimum choice of the date for the Allied landings in France was a correct judgement by Ike, which differed from the German Army’s conclusion.)

Each year, the accuracy of the Congressional Budget Office’s (CBO) budget revenue projections is compared to its past record. In fiscal year 2021 the projection was too low by 15%, three times the normal error rate of 5%. Outlays were too high by 4%, twice their normal miss rate. These projections were calculated after some midcourse corrections in March. The purpose of showing these misses is another example of skilled statisticians falling to Mr. Gilbert’s song title. 

I don’t have similar numbers for analyst misses in terms of sales and earnings for the same period. My guess is the private sector error rate was equal or more than the CBO’s. My concern, particularly for high P/E stocks with double digit earnings multiples, is that errors can start “to be real numbers” This may be particularly true if one wants to invest for periods of ten years or more.

Two Different Voices

This is the season where politicians and corporate managements tell us how good things are and will be with their fourth quarter and annual earnings announcements. Actions by consumers and investors are saying something different, with consumer spending in December slightly below November. It is possible consumers shifted to earlier holiday buying due to fear of shortages, although a recent walk through The Mall at Short Hills, a ritzy shopping center, did not reveal ebullient shoppers. This suggests very little business capital was used to expand capacity vs filling out the supply chain, although there was probably some inventory building on the industrial side. 

In terms of net buying of mutual and ETF fund shares, it was dominated by the buying international funds and the redemption of domestic equity funds.

Views on a Recession

Merrill Lynch market analysts believe the quickest way to a recession is a Wall Street Crash. Jeremy Grantham, a manager that has been early but correct, put out a very dire point of view in a piece titled “LET THE WILD RUMPUS BEGIN”. He portrayed a bursting of the US Extravaganza, taking stocks, bonds, commodities, and housing down to at least their base price levels. Barron’s headlined an article “The Countdown to The Next Recession Already Has Begun”. This article pointed to rising fed rates bringing on a recession in 2024.

We May Not Be Hedged Against What We Thought 

Suppose we have a $1,000,000 portfolio invested 90% in stocks and 10% in long bonds. If any of the thoughts expressed above materialize and stocks and bonds both drop at least 10%, you now have $900,000 portfolio. While you continue to be hedged against a relative decline of one of two asset classes, you are not hedged against the loss of $100,000. If you look at the purchasing power of your money, both inflation and foreign exchange could reduce the purchasing power of your investments.

Working Conclusion

Be prepared for a difficult market that will reset values, possibly for a few years. At the same time, maintain long-term positions for future generations. They will need it, because it is possible the world will restructure in an unfavorable way, but at least they will have a start.    

  

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https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html

https://mikelipper.blogspot.com/2022/01/current-causes-of-concern-weekly-blog.html

https://mikelipper.blogspot.com/2022/01/deeper-thoughts-weekly-blog-715.html

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Current View of 3 Past Lessons - Weekly Blog # 693

 

Mike Lipper’s Monday Morning Musings

Current View of 3 Past Lessons

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

What Little We Know About the Future

“The future” will be a series of never-ending episodes, some good, some bad. Each somewhat similar and different than the past. Analysts are a combination of historians, observers, and dreamers distinct from extrapolators. In pondering the future during a “dull market” week, I looked through three historical lenses searching for useful clues about what lies immediately ahead. Please remember my absolute right to be wrong, or perhaps worse, being half-right.

1. “The Dow Theory”

Charles Dow, the first editor of The Wall Street Journal and founder of Dow Jones in1896, spent time trying to interpret the stock market and what it foretold about the future. His analysis revealed that there were two stock markets, those of pragmatists and dreamers, using my terms. Today we might call them “value” and “growth” investors. To arrive at this conclusion he boiled down the price performance of what would become two limited indices, the Dow Jones Transportation Average and Dow Jones Industrial Average. He concluded that for the general market to have a sustained movement both averages had to move in the same direction and eventually reach their prior established peaks and troughs. One had to confirm the other’s move.

 The logic behind this view was the industrials being priced on the collective view of their future, believed only when the rails carrying their freight to customers confirmed it. We might have labeled the two indices as quality and speculation. (Some of today’s readers would not believe that the rails were the quality portion of the market. Some years earlier, Columbia University had an endowment devoted to the most prudent of all US investments-----railroad bonds!! It is worth noting that almost every significant railroad subsequently went bankrupt.)

Today, pundits still regularly comment and contrast stocks/funds that are value and growth oriented. With that in mind, it is useful to look at charts published each week on the price movement of the Dow Jones Transportation and Industrial Averages. (Both have evolved, with major changes in their composition. The Transportation Average includes airline companies, logistic companies, shipping companies, and package delivery companies. The so-called Industrial Average, in addition to including manufacturers, also includes entertainment, financial, credit card, and software producers.)

From the beginning of the current year into the middle of May, both Averages rose meaningfully. However, since then the DJIA has risen slower, being essentially flat in July and only reaching a slightly higher peak on Friday. The Transportation Average on the other hand has been falling and is now approximately 11% below its May top. Thus, as of now we have a non-confirmation of the Industrial Average Friday breakthrough. 

The May peaks in the two averages made sense as the rate of gain of the recovery topped out. This was primarily due to concerns over inflation, politics, and slowing sales resulting from shortages. While the NASDAQ also went to a record levels on Friday, on most trading days its price movement has been less ebullient than the DJIA. One of the characteristics of a top or bubble is high-volume traders going up while others lag or fall.

2. Jeremy Grantham (GMO)

Jeremy is an iconoclast thinker and portfolio manager. He has made some brilliant calls on the market and has been out of phase with markets for extended periods of time. More than a year ago he made a favorable call on the price of timber. As a member of Caltech’s investment committee, we have profited and enjoyed his performance. He is currently worried about a market bubble. Recognizing that many who attempt to read crystal balls concerning their future eat broken glass, his views are well worth considering:

• Bubbles occur when periods of very long and strong economic expansions are extrapolated into the future. (The current expansion is being fueled by government stimulus, with the advocates not identifying any termination of the expansion.)
• Much of the global expansion of the last several years has resulted from bringing low-cost labor from China and eastern Europe into production. (Unless they can cheaply be replaced with Africans, Latin Americans, and those from Southern Asia, we will suffer from wage inflation.) 
• Perceived wealth makes consumers and investors think they are wealthier than they are. While seasoned market investors understand that prices “temporarily” decline, few appreciate that housing prices can fall for a long time. In terms of future spending, housing is a worse investment than securities. (It is my personal view that we don’t own our homes, they own us. We must pay to maintain them and pay taxes on them.)
• He lists other parallels in a recent podcast and his writings.

3. My Own Experience

My first job on Wall Street was at 63 Wall Street, working at one of two very special brokerage firms. With rare exception the two firms were odd lot brokerage firms, executing share transactions of under 100 shares. Other members of the New York Stock Exchange (NYSE) found this task cumbersome in a pre-computer era. To free themselves of this burden they allowed the odd-lot broker to charge an eighth or a quarter, depending on the price of the closest qualifying trade executed by the other floor members. With their level of commission determined, the two firms competed to get orders from other firms by providing services to their customers. During this period the only record of stock prices was on Mr. Edison’s ticker tape, which was not mechanically stored. My job, along with an army of clerks, was to record the tape prices and volume for a handful of stocks useful to our brokerage firm customers, proving they got the best possible price at the time of the trade.

I learned a great deal that summer which shaped both my later career and more importantly how the real commercial world worked. Some of these insights were:

• If commissions are fixed, one competes on services that are a burden to customers.
• With the right sales attitude, it is a distinct advantage working for a limited number of professional customers in geographically close offices, rather than dealing with public customers spread around the country, if not the world.
• Internal industry competition can regulate the marketplace faster, fairer, and more insightfully than regulators.
• Develop respect and appreciation for skilled hard working people with different levels of formal education and experience.

Many years later, when assembling a financial services portfolio for family and clients, I did not limit it to brokers, banks, insurance companies and fund managers as most financial services portfolios do. I also included financial service companies with specific expertise useful to the professional market. In a recent performance review of that portfolio, some of the leaders were what I would call critical common denominator service companies with limited competition, e.g. Moody’s, Thomson Reuters, and S&P Global in personal accounts,  which have gone up multiples of our original cost.

The reason for mentioning these positions in a blog focused on what could cause the market to decline, is that almost every business is overregulated compared to other financial services businesses that are relatively lightly regulated. This is due in part to the same customer regulation that the odd-lot firms enjoyed. If some of the comments by Senator Warren and members of the current administration become law, it will make these companies less attractive investments and worse suppliers to the market.

Updates

Some of the signs of extreme inflation are possibly temporary. The runaway JOC-ECRI Industrial Price Index declined this week by 3.64% and is only up 68.27% year-to-date. I don’t know how much of the decline is from certain lumber and oil prices. Personally, I am much more concerned about service sector inflation due to rising wages. Some of this is overdone, but it is unlikely these hard-earned increases will meaningfully reverse short of a major depression.

When I talk with young people these days, they focus on trading to get rich quickly. I try to bite my tongue for I believe that investing is an art form, where each artist learns how to control their actions to reduce the probability of losses and the possibility of gains overtime. To me, trading is an inside game for professionals who believe that they have a demonstrable edge capable of overcoming expenses and taxes. Many of these young people go to or graduate from “good schools”, where they are taught and schooled, but not necessarily educated. Being schooled is what you have been taught, whereas education is what you have learned. Unfortunately, most of us only get education through our own or others’ losses. I am not worried the youth won’t get the benefits of losses, as that is almost inevitable through trading. What concerns me is that this generation will stand shoulder to shoulder with those who lived through the 1930s Depression, stoutly proclaiming “never again will I trust the market and its participants”. Some of these types of people were still at the Bank I joined after The Marine Corps in 1957. They relatively quickly past by those of us who were learning to be good analysts and not bad investors. My fear is that many of the youth today will never be good investors,  which may be the real loss resulting from the oncoming decline in markets around the world.

In Conclusion

The odds favor a major decline in the future. The issue is one of timing and we continue to learn that the duration of cycles of all sorts appears impossible to predict, but one should be prepared.

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https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/07/mike-lippers-monday-morning-musings_25.html

https://mikelipper.blogspot.com/2021/07/correcting-impression-and-gaining-some.html

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The Wisdom of 3 Wise Men - Weekly Blog # 663

 

Mike Lipper’s Monday Morning Musings

The Wisdom of 3 Wise Men

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

                   

Those who spend a great deal of time, energy, and emotion investing are truly “career” investors, whether they do it for a fee as a professional agent or as a personal investor. The successful ones focus on areas beyond security selection, including policy decisions. They are scouts leading away from capital destruction and toward capital appreciation. To do this, their natural position in the march of time is to be way ahead of the parade of followers of current trends. Successful investors are often lonely, fearful of falling into an avoidable trap, often searching for clues that others have found.

US investors will suffer a new government beginning in ten days, made up mostly of career politicians who participate in a former government producing slow, uncertain growth and loss of relative strategic power. Asia, particularly China and to a lesser degree India, plus the Middle East and Africa, represent challenges and opportunities likely to drive higher investment returns relative to those in Continental Europe. Under these circumstances, as a contrarian, I am paying attention to three investment wise men.

Jason Zweig wrote in this Weekend WSJ, “In theory investing is all about markets: in practice it is more about marketing.” Jason was addressing the old tale that stocks and funds are not bought but are sold, largely based on the marketing of past performance. The easy approach for salespeople and others is to extrapolate the immediate past. In the commodities markets, which often exhibits long trends, there is the motto “the trend is your friend”. My study of sports, economies, politics, and markets is that all trends either end disrupted or exhausted. The longer the trend, the more competitive forces will seek to replace the presumed longevity of the trend.

Jeremy Grantham of GMO points to the career risks of being too premature about future drastic changes in direction. He was admittedly three years early before the Japanese market topped out. In another instant, he lost half his clients in one strategy by being premature. The lesson here is to gradually withdraw and add to various sectors or philosophies. While it may be emotionally satisfying to go “all in” or “all out”, it is extremely arrogant in terms of career risk. We should also remember that the prime function of markets is to create humility. We can be wrong.

Benjamin Graham has been called the Father of Security Analysis and was a successful fund manager with both wins and losses. He said “Never mingle your speculative and investment operations in the same account, nor in any part of your thinking”. I don’t remember when I came up with the idea of creating sub portfolios for different purposes, but earlier he was focusing on different approaches for different investment purposes. At the racetrack it is called “different horses for different courses”. 

I often advocate sub-portfolios for different time periods to meet spending needs. As the weakest securities disappear in terms of impact over time, the longer a portfolio functions the greater the odds of success. Almost all the accounts we have held for twenty years or more are profitable. Under today’s conditions of increased uncertainty, I wonder whether two new sub portfolios should be set up. 

• The first would have a four-year duration based on the probability that much of what the incoming administration accomplishes will be reversed by a new administration in 2024. I am particularly focused on tax rates and regulations. 
• The second trading portfolio would have a one-year focus based on the effective timing of new legislation and executive order implementation. It would trade on the rumors of the progress of various political actions. 

Despite the financial media focus, the bulk of equity investments are long-term, both for retirement and estate building purposes. We have just finished an above average ten-year period where US Diversified Equity Mutual funds averaged an annual gain of +12.69%, with the median fund rising +11.71%. To do better than these results one needed to be invested in growth-oriented funds, which were more volatile than other stock portfolio peer groups. I have doubts that the next ten years will be as good as those in the past. Considering my outlook for interest rates, inflation, the value of the dollar, demographics, and technology, performance of no more than half the level of the last ten years might be viewed as heroic. One might even predict a lower return. (Interestingly, if we did experience a low ten-year growth rate, the following ten-year rate would probably be much higher.)

Current Updates

• For the first week of 2021, the average S&P 500 Index fund gained +1.30% vs +2.59% for the average US Diversified Equity fund, continuing the pattern of underperformance delivered in the last half of 2020.
• The AAII weekly sample survey of its members’ views for the next six months is 54% bullish and 26.6% bearish. Market analysts treat this as a contrarian indicator. 
• An interesting mathematical insight is that these ratios are approximately 2 to 1. They are in the extreme range and I would not be surprised if they reversed, with the S&P Index funds doing better and the six-month trajectory of the market doing worse.
• The JOC-ECRI Industrial Price Index remains stubbornly high, generating a +26.6% gain year over year.
• Truck tonnage carried is moderating an early spike.
• The S&P 500 was up for the first five days of 2021 and more often than not that heralds a positive year. The full month of January is a stronger predictor.

Critical Question:

Do you regularly examine your investment policies or is most of your attention spent on security selection?

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https://mikelipper.blogspot.com/2021/01/anticipating-topping-us-stock-market.html

https://mikelipper.blogspot.com/2020/12/stud-poker-new-swamp-game-weekly-blog.html

https://mikelipper.blogspot.com/2020/12/mike-lippers-monday-morning-musings.html

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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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Signs of Enthusiasm, China Concerns, Centurions are Coming

Introduction

Because I like to think about different timespans as an improved way of managing money, I look at different stimuli in terms of impacts on those timespans. The focus of most commentators is on the short-term, which can be described as until the next performance reports all the way out to the rest of the market cycle. Some focus on intermediate periods that follow after the current cycle. And very few will focus on the long-term needs in terms of their responsibilities. Nevertheless, it may be useful to arrange some of the stimuli that bombard us each day.

Short-Term

On the very day of the publication of the statement of President Trump  “Pittsburg Not Paris,” the three major US stock indices went to new highs. The enthusiasm for stocks is global with five markets showing 2017 gains of over 20% through Friday: NASDAQ +27.06%, Bovespa +25.57%, Hang Seng +24.87%, IBEX 35 +22.31%, and FTSE 100 +21.9%. While a number of the gainers are being driven by advances in Emerging Markets, it is not as usual supported by or led by commodity prices.

Based on past history, two cautionary notes should be observed. The first is a reported statement from an old friend and "bubble watcher" Jeremy Grantham: "The US market has entered an era of permanently higher valuations." (A look at history questions whether any valuations can be permanent. This is Bull Market talk.) The second was noted in Barron's based on the work of Bespoke which commented that April margin balances were the fourth consecutive month of record levels. Bespoke observed that the last two bear markets have occurred after margin balances have peaked.

At the moment I view all of these inputs as cautionary signs. In the past, important peaks have been the result of greater amounts of enthusiasm with higher performance numbers, new "geniuses" and considerable leverage. I am not predicting this, but at prior peaks I have seen a number of mutual funds that reported gains of +100% or more. At this time we do not see people changing their lifestyles and marriages based on their new theoretical wealth.

China May Dominate Intermediate Periods

The generally accepted view is that China will become the globe's number one economy within the foreseeable future. My own opinion is to always be cautious about generally accepted views, they have proven to be wrong too often in the past. In addition, the Chinese economy and society are highly leveraged operationally and financially and things can go wrong. At the moment, I feel confident that China will become the most important variable in determining future investment policies around the world. With those thoughts in mind I will summarize two important inputs. The first is from our friend Byron Wien's reaction to his recent trip to Asia (including China) speaking with institutional investors. The second are the views expressed by the portfolio managers and investment strategist with which I visited recently.

Byron Wien's China Briefs

• Capital formation is growing 4% with inflation at 3%.
• Leverage is the major problem with total social and financial borrowing  250% of GDP.
• Interest payments are 14% of GDP.
• Shadow banking interest rates are 14%.
• Regulators will permit banks to convert non-performing loans into equity.
• Return on equity for private companies has dropped from 18% to 9%.
• Equity market valuations are high at 20x with meager growth.
• Middle class expected to reach 60% by 2020 from 43% in 2015.
• Population is rapidly aging and expected to reach 370 million in 2050 vs. 170 million in 2015.
• Healthcare expenditures are 5.5% of GDP.
• Life Insurance covers 2% vs. 10% in developed markets.
• The solution to excess industrial capacity and jobs is "One Belt One Road."

Matthews Asia's Mindset

In response to the expected downgrade of China's credit rating, Moody’s* points out that the bulk of the excessive leverage exposure is in the largely State Owned Enterprises (SOE). I believe most of these loans are held domestically by government owned or controlled banks. The key social issue is jobs. Luckily the majority of employees work for private companies that are profitable. Actually the private companies are growing their earnings, but the periodic waves of speculation have been reacting to both global and internal political trends depressing their prices. (This is just the opposite of India, the best performing large market this year, where earnings have not met expectations. The enthusiasm for the current political and monetary conditions has driven the stock market higher.)

*Held in the private financial services fund I manage

Matthews Asia sees future opportunities in both Micro caps and some of the under-followed "A" shares. In its portfolios that invest in China, Matthews Asia is investing in both the creation and the use of technology applied to health care and related aging needs. With China being such a big part of Asia's future, one would assume that in the long-run Matthews Asia believes that China will be a positive for Asian investing.

My long-term concern about China is that the global history of railroad and port building with too much leverage can create unexpected volatility.

"Beware of the Centurions" in the Long-Term

If my memory of military history is correct, in the conquering armies of Rome the key maneuvering units were comprised of one hundred men commanded by a Centurion. It was the Centurion that transformed a diverse group of undisciplined men into a well trained disciplined military unit. We are entering an era when an increasing number of people will be at least 100 years young, and we and they are unprepared for this transition. A thoughtful piece by John Mauldin alerts us to the demographic fact that increasingly we will be dealing with people that pass the century mark. As individuals and as a society we are not prepared for this change. For example when Social Security was initiated in this country it was based on the belief that men would retire at 65 and die at 67. This was conservative in that people born in 1930 had a life expectancy of 56 for men and 62 for women. Compare that with life expectancy for those born in 2007 to be 103 and 104 respectively, in the US. This is a global phenomena with six other developed countries’ expectancies in the same range. Japan is the leader with 107 years.

One of the unspoken conceits of investors is that they are not the average person. To the extent that they can prove that by being wealthier, the top 20% on average in terms of wealth, are expected to live five years beyond the average. The poorest are expected to die two years earlier than the average. I can understand the distinction because of diet, less risky manual labor, and quality of health care. I don't know what assumptions are built into these projections as to the developments in medicine, agriculture, working conditions, and psychological health. Further my basic training at the Racetrack and the US Marine Corps questions trusting averages but has a distaste for being in the middle of any group.

Regardless of the projections, as societies we are not doing a very good job of caring for the present seniors. Fundamentally the reason for this is we have insufficient dedicated capital. This is a global problem impacting all the developed world and many of the developing countries. Almost every government-sponsored pension plan is underfunded to meet the present retirees, let alone prepared for the Centurions.

Strange as it may seem, I see this is an opportunity for investment gatherers and managers. As Centurions grow in number, increasingly they will exercise their votes at both the local and national levels. I expect at some point we will evolve into a two level tax system where there will be charged a higher level for consumption spending, perhaps some type of VAT, and a lower bracket for retirement spending. Whether any unused capital can be passed on without a tax, I don't know. Further our laws and practises will react to some concept of age discrimination in favor of utilizing the best people for the job in one form or another. Unless we do something, the Centurions will weigh heavily on our productive capacity.

Critical Investment Question: Rank which is most important to you and your investments: (a) short-term market outlook, (b) impact of China, or (c) providing increased retirement capital. Please share your thoughts with me.

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A. Michael Lipper, CFA

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