“SMART MONEY” Acts Selectively - Weekly Blog # 819

 

Mike Lipper’s Monday Morning Musings

 

“SMART MONEY” Acts Selectively

 

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

  

 

 

Dull Week with Some Clues

The stock market from mid-December through this Friday was flat, except for an early bubble in January. (I suspect the NASDAQ price surge resulted from the replacement of some holdings sold for tax purposes in the fourth quarter.) Market analysts suggest a flat price pattern might represent the smart money either accumulating or distributing meaningful positions. This suggests prices will either move up sharply or fall rapidly after a period of time. I will attempt to examine what I perceive as clues to future major moves.

 

NYSE and NASDAQ stocks declined for four of five days in the latest week. The DJIA rose for three days and the more professionally followed Dow Jones Transportation Index fell for three days. As a contrarian measure, analysts watch the latest weekly summary survey published by the American Association of Individual Investors (AAII). In the latest survey, participants raised their 6-month bullish prediction to +48.6 % or double their bearish guess of +24.2%. (Lucky for those who work in the market and those who live off of it. Individual investors have a good long-term record. From a contrarian viewpoint following them has value, because they are wrong at critical turning points.)

 

The number of publicly traded companies has been dropping for many years, mostly due to acquisitions, not failures. In 2023 there were 15,766 IPOs vs 17592 the year before. More significantly, the money raised dropped to $170 billion from $242 billion.

 

There are several thoughtful columnists who occasionally focus on financial history. John Authers of Bloomberg wrote “America is disinflating…disappointingly slowly.” He believes a major future expansion would require more problems than are currently visible. James Mackintosh of the WSJ warns investors that the market goes up and usually produces satisfactory returns in most 20-year periods. There are a few times it does not. (It’s important to remind investors that there can be times when investors won’t be bailed out in a given 20-year period. I wonder if that is why 30-year bonds and mortgages were created.) I believe he would have more confidence in recoveries if interest rates were set by the market and not by government fiat.

 

One problem with many economists, both within and outside government, is that they do not have enough appreciation for lessons learned from Asia and the Middle East. For example, we don’t seem to appreciate the products and technology that came to the West along the Silk Road. The following is a list of products or services that traveled the series of trans-Asian roads:

 

Silk, Hemp, Cotton, Wool, Paper (Paper Money). Fireworks (Explosives). Gunpowder, Tea, Horses, and algebra from India.

 

Working Conclusions

Recognizing that I don’t know what the future will bring, I turn to my investment/betting framework for a relatively conservative perspective. For the time period ended early 2025, I suggest there is a 60% chance of a significant US equity decline. The decline will perhaps be in the neighborhood of 20%, with an outside 50% chance of a full depression with an 80% drop. There are also two other possibilities at 20% each. First, a 5-7-year period of stagflation, and second, a 20% chance of below 4% GDP growth.

 

For estate planning purposes with a 30-year outlook, expect equity returns to be in the 5-9% range.

 

Your Thoughts?

 

 

 

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Mike Lipper's Blog: Solo Messaging is Meaningless - Weekly Blog # 818

Mike Lipper's Blog: Our Wishes & Perspectives - Weekly Blog # 817

Mike Lipper's Blog: Dangers “Smart Money” & Thin Markets - Weekly Blog # 816

 

 

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Longer to Rise, Faster to Fall - Weekly Blog # 544

Mike Lipper’s Monday Morning Musings

Longer to Rise, Faster to Fall

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

One of the most critical tasks for good analysts is to anticipate both the near and far term futures. We know that we will be wrong some of the time in terms of direction and frequently and will be in error on the numbers themselves. We take comfort that our fellow prognosticators, the weather people, are still employed. Both of us tend to have better records than either economists or politicians. The reason for the better record is not that we are brighter, but that we are constantly looking for surprises that could cause trend reversals. The others are much more comfortable in extrapolating the present into the future.

Each day and each week I look for potential surprise elements that I occasionally share with you. To put some perspective into my observations I place my views in different time slots, which may be useful to our subscribers even if you haven’t adopted our sub-portfolios of different time spans.

Most of the US market indices are near their historic previous high points but appear to be laboring in an effort to go higher. My friend, Byron Wien, said that the “market could move somewhat higher, but that a major surge is unlikely”. Byron was not in the US Marines with me training in the undulating hills. My experience is that it takes a long time to get up a steep hill, but the fall on the other side happens quickly. This matches our historic market experience and reinforces my belief of identifying different time spans for different tactics. The rest of this blog contains inputs that I received this latest week, broken down into times when they appear to be most important.


Need for Operational Cash or Short-Term Considerations 

The picture is mixed as shown below:

• September slow-down in sales orders

• Jump in wholesale inventories (could be tariff or price increase related)

• Generally rising stock markets in US, China, and Japan

• Closing daily stock price gaps for DJIA and S&P 500 

• Center parties losing some power in Germany, France, and Italy

• US restaurant shortage of experienced staff

•  Of the larger investment objective averages, the following beat the S&P 500 index funds for 2018 year to date: Small-Cap Growth, Health/Biotech, Large-Cap Growth, Science & Technology, Mid-Cap Growth, and a number other popular fund objectives. Leader-ship is broader than just the FAANG stocks.

• Only three types of fixed income funds gained over 1% on a total return basis year to date: Loan Participation, High Yield, and Ultra Short Funds. As with most other fixed income funds, net asset values were flat or down, leaving only their dividends on the positive side.

• In the past week, five of the six best performing indices were commodity related indices. The two best currencies were viewed as commodity currencies. 

• There was a significant slow-down in net sales for the world’s open-end funds between the first and second quarter. According to a compilation done by the Investment Company Institute, the $584 billion net sales in the first quarter was down to $194 billion in the second quarter. This was materially less than the $609 billion in the second quarter of 2017. Even so, the fund industry is a powerful force in the investment markets, with global total assets of $53 trillion.    

Until the End of the Next Recession and Market Decline:

• Byron sees the next recession after the 2020 presidential election, but the stock market may anticipate earlier.

• Jeremy Siegel, Wharton Professor and Consultant to Wisdom Tree (*), believes “stocks are overvalued and bonds are enormously   overvalued on a long-term basis.”

• Studying mutual funds since the 1960s and knowing their history before then, it is very rare to find a professional investor that es-capes a major decline and then is successful in re-entering the stock market at a propitious time. Cash makes us too comfortable.  

Legacy Investing: Stay in the game

• John Authers, one of the most read columnists in the Financial Times, has written a column on what he has learned from investing his fund journalism prize in 1992 and the good record it produced. He invested in a mutual fund which had a good investment record, which he continues to hold. The points he has learned are: 

• There is not a great deal of difference in performance over the long-term between an actively managed middle of the road fund and an index fund, if it existed at that time.

• He and most investors have a home country bias.

• One should expect portfolio managers to change and for there to be changes within the management company itself.

• Jason Zweig, another old friend, recounted in the weekend edition of The Wall Street Journal that there are periods when various markets outside of the US perform better than the domestic market. He believes that the trend of US investors investing in funds invested outside of the US will be rewarded. As pointed out by a manager at T. Rowe Price (*), foreign markets from a US prospective have less tech growth stocks and thus their markets are selling at a lower valuation.

• I have made the point to an investment group that I participate in, that currently a good way to hedge US holdings is to invest long-term into China, either directly or from my standpoint thru mutual funds.

My Conclusions:

Investing is like predicting the weather. It’s almost impossible to predict the levels of the market, particularly with shifting levels of sentiment and liquidity. Getting the trends right is often the best one should hope for.

As most artist’s don’t exactly know which of their works will achieve lasting acclaim, we should recognize that it is at best an art form or an intelligent gamble when properly managed.

Investing with different approaches for different time spans allows one to have more tools than a single portfolio with a single strategy.

At the moment I believe we are climbing a wall of increasing worries. It’s like climbing a series of difficult hills, always aware that most declines are marked by surprises which lead to a quick fall.


Question: how do you see the long-term outlook?


(*) A long position is held either in a private financial services fund or a personal account of mine and do not represent a recommendation

 
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Different Forts: Misconceptions on Risk-less Investing + 3 Reasons for Equity Mutual Fund Redemptions - Weekly Blog # 497

Introduction

Attorneys in court often arrange “the facts” to support a conclusion. Economists and Professors of Finance suffer from “physics envy” of immutable laws. Politicians and pundits speak in sound bites. Investors, like other good judges, look at all of the information found in hard and soft data. Most importantly, investors should avoid accepting any proposition on the face of what is presented. Wise investors have learned to probe for a more complete understanding of what is on offer. 

Is Risk a Number?

Pity the poor professor introducing investments to a class. He or she finds it easy to introduce the concept of gains. It is essentially one of addition or in some cases multiplication. The problem is to introduce the concept of losing which is similar to subtraction. The real issue is to come up with a way to measure potential rewards vs. potential losses to get to a conclusion as to the risk of an investment. In the search for a mathematical answer rather than a deeper understanding of the different kinds of risks facing different investors, academia came up with the movements of US Treasury bond prices.  They measure the price pattern of the desired investment versus the volatility of Treasury prices. Thus, the idea of a “risk-less” rate of return was born. Investment sales forces deducted this so-called risk-less rate from the actual performance of a stock (and more frequently a fund or other portfolio) to create a comparison of favored investments, adjusting for risk.

While it is true that often the movement of treasury prices captures a reasonable amount of the general volatility in the stock market, for investors risk is the penalty for being wrong that causes changes in spending plans. It is these risks that cause pain to investors and their beneficiaries plus create “career risk” for hired professionals.

The use of Treasury prices presumes that there is no fundamental changes in the future of the Treasury market. Because of the changing market structure I believe that there will be periodic changes in the Treasury markets. In this weekend’s Financial Times John Authers has a column that is headed “Liquidity looms as the real challenge facing new Fed Chair Powell.” While he doesn’t spell out the problem, it is clear in the future he is properly worried that the various central banks led by the Federal Reserve will be cutting off credit through the banks to the fixed income market. While the Dodd Frank Act curtailed the commercial banks and large investment banks in their market-making efforts in securities, it did not really address the banks’ extension of credit to the few remaining market-makers. These credits are much larger than the banks’ own securities positions. There is already a shortage of repurchase agreements or repos at present. One sign of structural disequilibrium is that for ten year Government bonds, the US is paying 100 basis points more than the UK pays for its bonds and 200 basis points more than the German bonds. This suggests that the US paper is worth more. Why? I believe the reason is that it is the best collateral for loans that support borrowings for the purchase of derivatives and currencies which can be extremely volatile. Since most loans are immediately callable, there is the sort of risk that started the problems that led to the 1987 and Lehman crises.

  

Thus the ownership of a 4% yielding common stock or fund with a payout ratio of 40% or less and a price/earnings growth rate in the single digits versus a holding in US treasuries may be more dangerous in terms of risk to the investor and career risk to the professional. But these are unconventional thoughts.

Investors Rejecting Equity Mutual Funds

The constant drumbeat that retail investors are deserting mutual funds in favor of ETFs needs much deeper analysis than the pundits are giving it. For a number of months industry headlines have been screaming about the net redemptions of equity funds and this week is no different. Except they are missing the motivation behind the redemptions and its significance. The largest amount of redemptions is coming out of the Large Cap Growth funds. I do not believe that it is performance-related. On a year to date basis through November 2^nd,  my former firm, Lipper Inc., reports that Large Cap Growth funds, on average, have gained 26.03%.  No other non-leveraged, General Equity fund category has done as well this year or even in the last five years. The only other domestic funds that have done better are the Science & Tech funds. Some International funds have done better in part due to foreign exchange considerations.

Why are there so many redemptions?  There are three answers. The first is simple, the second is structural and the third has to do with the changes in the brokerage market.

The simple answer is that the Large Cap Growth funds have more assets than any other investment objective. Thus, logically over time it will have more redemptions. 

The structural answer is that investors put money into funds to meet future needs. The very day that someone invests in a fund, a future redemption is set up in the indefinite future. Because of the way many estates are settled, usually liquid investments are sold to distribute as much cash as quickly as possible so funds are not often directly inherited.

The third cause of redemptions relates to the fact that a large portion of investors in mutual funds was sold by commissioned-paid brokers. At the time of many of these transactions the commissions of mutual fund sales were among the highest rewards to the sales force. Currently many of these salespeople have morphed either into registered investment advisors or have changed firms for understandable reasons. In their new shops they are no longer motivated by commission sales but by investment advisory fees. As their books of business mature, there is little attempt to replace stock mutual funds in their aging accounts. These investors are converting their investments into either fixed income funds (whose sales are booming in spite of the likelihood of higher interest rates/lower bond prices), or into Exchange Traded Funds. In the latter case the investment adviser will charge an annual fee that within a few years will more than compensate for the loss of mutual funds sales commissions.

Hints For the Future

At some point before the current market suffers a major decline, there will be a more general recognition as to the risks in the fixed income market with higher yields driving fixed income prices down. The credit cycle in high quality paper will contract. It is likely that we may be surprised by the levels of domestic and international bankruptcies which won’t be isolated events.

On the equity side grudgingly we are seeing enthusiasm growing. In the last two weeks sentiment has become more bullish as measured by the American Association of Individual Investors (AAII). It will have to be sustained for a considerable period of time to fulfill a bear market indicator. In addition to Large Cap Growth funds and stocks doing well, industrial metals commodity prices are also ahead, showing a year to date gain of 25.11%. One of my senior analyst friends describes his current portfolio as a 1950s one. As many of the relatively newly minted investment advisors don’t have the historic perspective for the type of market we appear to be entering, they will disappoint some of their customers leading to a positive surge in equity mutual fund sales. (As an owner of a number of domestic and international mutual fund management company stocks both in my private financial services fund and personally, I hope so.)

Question of the Week:

For your own account how are you defining risk?  

__________

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Shorter-Term Worries, Longer-Term Opportunities

Introduction

We are not enjoying complacency about securities' prices, we are suffering from petrification. One of the supposed benefits of holidays be they secular such as Labor Day, bank holidays or religious fast days, is it gives investors and those who are dependent upon investors a chance for introspection.

On the surface we are experiencing relative calm with the month of August posting the second lowest volatility in a decade of S &P 500 performance. I have yet to meet any professional or individual investor who is happy with the markets - stock, bond, or commodity. The relative lack of movement is anything but creating complacency but rather a deep seated fear of being wrongly positioned for the next market. Until magically they see further into the future than they are now, investors are petrified to act.

Short-Term Worries

Several new books and other long treatises can drone on as to all of the problems facing our global societies, economies, political leadership and securities markets. I am going to list a number of concerns that occurred to me over this three day weekend and it is not an exhaustive list:

1.  Over-valuation of leading components of popular securities indices due to flows into passive portfolios, including ETFs. These buyers are participators not evaluators.

2.  A record level of long contracts on the Dow Jones Industrial Average. (This level of speculation is normally wrong. However, in today's world I wonder how many of these contracts are paired with shorts on individual stocks.)

3.  Moody's^* warns "take cover if defaults climb through 2017."

4.  John Authers of the FT in suggesting rules for investing success, recommends the need to be humble as the markets are not perfectly efficient and the greater the price paid for a security the lower the potential return.

5.  In a recasting of the famous economist's view of a “Minsky  Moment,” the illusion of control encourages risk-taking behavior. Much of what is being pitched these days is expressed as low risk due to the fact that they are government actions and in the past history few things have gone bad.

*Held in the private fund I manage.

In the latest Marathon Asset Management Global Investment Review, the London-based firm tells the story of a famed Soviet professor of statistics who regularly did not take shelter during the Moscow air raids in World War II. When asked, he pointed out that there were seven million people living in the city and one elephant living in the Moscow Zoo. Thus he felt comfortable not going into the shelters until one night he showed up at a shelter. He then announced that the prior night they killed the lone elephant. The message: Change when the facts change.

Longer-Term Opportunities

This weekend I sat next to another guest at a wedding; she had worked in development at Yale before it was famed for extraordinary investment performance, but during the period that it was building that record. We chatted about the Chief Investment Officer who had introduced alternatives to stock and bond portfolios. We concluded that one of the reasons for Yale's success during that time was that few or any of its major academic competitors were taking advantages of these opportunities.

During the current period of complacency/petrification I see a similar opportunity. Too many very bright investors are focusing on the current (apparently insurmountable) problems and not at the opportunities that always exist but too often are hidden to us because of our perception deficits.

Keith Ambachtsteer contributed an article to the FT entitled "Long-term thinking will lead the way to improved returns." He knows by experience in affecting a number of Canadian and to a lesser degree, US pension funds. His focus is to keep the attention on the long-term and not get bogged down in the short-term.

If one does focus on the longer-term, an investor has two mathematical advantages working in his/her favor. The first is the compounding impact of reinvesting income. Over the last five years the reinvestment of distributions from the stocks in the Dow Jones Industrial Average raised the DJIA total return by 33.85% over its simple price change gain. The second mathematical power going for investors in the long run is that almost all of our lives we have been in a period of secular growth with both demographics and technology helping to enlarge the demand for what we produce.

During a period when the negatives are being accentuated, too few people are searching for positive opportunities. In the US and some other countries, we will have both new political leaders as well, I believe, quite different legislative bodies. Perhaps we will also have some movement in the judiciaries. As much as many would like, they are not going to be able to slavishly copy what was done in the past. Even slight changes will create opportunities for those who are looking for them. Major changes can create major opportunities. I believe we will see many. 

While it may be too early to tell, one should look for ways to foresee changes in both the labor and consumer markets. As an example, keying off this weekend's news of the poor showing of Germany’s ruling party in Angela Merkel’s own district due to the rise of an anti-immigrant party that has potential implications in Germany, the rest of Europe and possibly the US.

How to Play

During these uncertain times I believe our preferred structure of sub portfolios addressed to specific time spans can be of particular value. Regular readers may be familiar with my TIMESPAN L Portfolios^®.  I would suggest that the need to meet payment requirements over the next couple of years will require close, very short-term management that is extremely sensitive to changes of credit conditions and shifting short-term interest rates. (The first, or Operational Portfolio.)

The replenishment requirements of the expended operational funds (the second or Replenishment Portfolio) probably need to deal with at least one down market year before the new government leaders leave office. On the other hand, investing for endowment (the third portfolio in the series) and other intermediate and long-term money have a great opportunity to invest wisely in less popular investments. For the truly long-term investor there will be ample opportunities to invest in both new and established disrupters.

Question of the week: Please help me find disrupters, what are your current favorites? 

_________________

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Copyright © 2008 - 2016

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.