A Different Year End Blog: Looking Forward - Weekly Blog # 869

 

 

 

Mike Lipper’s Monday Morning Musings

 

A Different Year End Blog: Looking Forward

 

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

 

 

 

Using Mutual Fund Data for Other Investors

Mutual Funds reveal their investment performance to the public every trading day and reveal their portfolios quarterly. In many cases the funds are managed by large investment managers responsible for other accounts. Their portfolios by implication reveal some of their philosophy of investing for other accounts.

 

Each week the London Stock Exchange Group publishes fund data that I used to produce. The report tracks 103 equity fund or equity related fund peer groups. Using the last five years of data, the shortest time period one should use in assessing investment performance, only 17 peer groups beat the +14.58% five-year return of the average S&P 500 index. (In selecting funds, I prefer to use 10 years.) There were three peer groups that did better than the S&P 500 Funds Index:

• Science & Technology +17.72 %
• Large-Cap Growth +16.62%
• Energy MLP +14.64%

Remember these are averages, so within the peer group some funds did better or worse than their group average. With only 16.5% of the groups beating the index, I question whether we are preparing a base for a meaningful general stock market advance.

 

Current Structure of the Market

The last four trading days of last week may not be significant but could be. The next two trading days will probably be dominated by last-minute tax-oriented transactions initiated by market makers or late players.

 

In the last four days 49.4% of the shares on the NYSE rose, while 55.8% rose on the NASDAQ. The more bullish NASDAQ players generated 205 new highs, compared to only 73 on the NYSE. Investors participating in the weekly AAII sample survey have been moving toward neutral in the last three weeks. Three weeks ago, the Bulls represented 43.9%, but they only represent 37.5% in the current week. The Bears only increased by 2.4% to 34.1%.

 

Possible Longer-Term Signals

Both political parties feel they should direct the private sector to a much greater degree than in the past. The latest example of this is the FDIC, which has wrung an agreement from the NASDAQ to limit the amount of ownership in small and regional banks. This a long echo of the “Money Panic of 1907” that Mr. Morgan solved in his locked library, which led to the creation of the Federal Reserve. A generation later the US government realized the Fed couldn’t help local farmers, their banks, and suppliers, so they passed the Smoot Hawley tariff bill, which was reluctantly signed by President Hoover.

 

Both the good and bad leaders of many countries recognize that the US has not won a war since WWII. Consequently, the growth of China in many fields is disturbing. Tariffs may protect some US businesses at a huge cost to lower income consumers and eventually isolate the US from growing markets, diminishing our military strength.

 

These issues and others are what we will be dealing with in the new cycle we have entered.

 

We wish you, your family, and friends a healthy, happy, and prosperous New Year.

 

 

 

 

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The Rhyme Curse -Weekly Blog # 838

 

         

Mike Lipper’s Monday Morning Musings

 

The Rhyme Curse

 

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

   

       

   

^{Analysts, lawyers, and accountants spend much of their careers relying on history to protect themselves and their organizations. I have often said, cut an investment analyst and a historian will bleed. Mark Twain is incorrectly identified with the following quote “History does not repeat itself, but it rhymes.”  To select the most useful rhymes, you should select from all past observations as an “AI” search would do, rather than just using the most useful observations. For example, in reviewing the number of years between the S&P 500 “all-time highs”, including 1929. There were 15 such occurrences, but they were of different durations: 25, 6, 5, 3, and 1-year durations). The most common period was one year, with 6 out of 15 periods being 1-year durations. In attempting to pick a relevant number of years, you should look at other factors. I would pick periods of rising government deficits. The center of this array is 5-6 years, suggesting a cyclical recession and possible periods of stagflation. A longer duration would imply a structural recession.}

 

^{Historical Inputs of Relevance Today}

^{In the 1890s US Admiral Alfred Thayer Mahon wrote on geopolitics and pointed out that Great Britain, a geographically small nation, was the real leader of the world due to its naval and commercial fleets. Both Germany and Japan got the message, which was fundamental in their preparation for WWI and WWII. China once had the largest fleet in the world, before they destroyed it themselves.}

 

^{The result of this seminal work was that once Germany was able to send its battleships through the Baltic to destroy British warships, WWI became a certainty. Prior to that the German General Staff, thru visits and other studies, had focused on the campaigns of General Stonewall Jackson in the Shenandoah Valley of Virginia, demonstrating the power of using mobility against fixed forces. After it’s treatment as an “ally” during the signing of the Peace treaty and the US curtailing its oil supply, Japan recognized the need for sea power, an issue which led to Pearl Harbor. Bringing the lesson and its probable impact on our future up to date. China has the largest naval fleet in the world today, and it is still growing while the US’s fleet declines.  China has almost half of the world’s shipbuilding capacity.}

 

^{Preparing for the Future}

^{The Capital Group, one of the great mutual fund and institutional investment managers, has entered into a joint venture with KKR to produce and sell hybrid funds. JP Morgan Chase, an organization that internally studies many possible futures, is prepared for interest rates between 2% and 8%. Their CFO is prepared for the tailwinds currently helping them to switch to headwinds.}

 

^{Many Different US Markets}

^{The only US Diversified Equity mutual fund sector to rise during the week through Thursday was large-cap growth funds, which was echoed by tech sector funds. While the NASDAQ advances volume rose for 4 days in the week, the NYSE Composite Index only advanced for one day. Low volume has led to less volatility.}

 

^{What Many are Not Prepared for}

^{The average age of world government leaders is 62, with 19% in their 70s and 5% in their 80s. The median age for US senators is 65, with the House member median age being 52. The average CEO is 56. While I hope all of our leaders are in good health and remain so, I suspect the emotional strain and lifestyle choices are incidental hurdles. As they age, they often become more conservative and prefer the old way of doing things.}

 

^{Investors are not prepared for change. I am currently noticing an increase in the rate of top spot replacements. Investors should therefore be prepared for leadership changes, which almost always result in younger and more vibrant leaders. There are other changes few are ready for, like a change in the Fed and other regulatory bodies, or a change in policies. I suspect there will be changes in private investments and how they deal with the public. As usual, low-risk equity and debt not designed to survive either stagflation or a major recession will come in late the.}

 

^{Let me know what investors need to be prepared for.}

 

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Investment Thinking During a Lull - Weekly Blog # 802

 

Mike Lipper’s Monday Morning Musings

Investment Thinking During a Lull

 

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

 

 

 

The most important and precious investment commodity is not money or reputation, but our time. Throughout a good bit of 2023 the US stock market rose and fell but went nowhere in many weeks. Perhaps we have entered a period of stagflation, with our cash flow squeezed by rising expenses and slowing gross investment returns during periods of low equity volume. In other words, it was dull despite what happened in the economy and political sphere.  

    

Many of us wasted the most precious investment thinking of our time. Most investors focus their time on trying to guess the next integer of return in their portfolios, when they should be estimating the cash flow needed to meet expected expenditures. Second, we should attempt to estimate a termination value at death, or the liquidation of the estate. 

 

Far too many investors have a collection of securities resulting from transactions focused entirely on the reasons to buy or sell a specific security. This can be appropriate if you are blessed with specific trading skills. However, very few are so blessed. Over time, most investors get more benefit from a diversified portfolio. One such portfolio for a newly retired person not expecting to trade the account might have the following components:

• High quality long-term fixed income (1/2 in US Treasuries and ½ in AA corporates)
• Large-Cap Growth
• Asian Equities (Exporters or high savers)
• All-Cap recovery candidates currently producing net operating cash flow below average for the last five or possibly ten years.

It is not important for this exercise whether one agrees with the sector choices. 

 

The key to the exercise is that each sector is assigned a weight. The job of an intelligent portfolio manager is to set the outer limits for each sector. When a sector’s boundary is breached, an adjustment should be made to return the portfolio to a sensible balance. 

 

Many of our big winners were established early in our investment history. It would be unwise if most of our winners were bought at roughly the same time. A good portfolio should have a combination of new and old winners based on the current situation, including key people. 

 

Prices move throughout time, often based on “leaks”. Studies of leaks reveal that between ¹/₅ and ¼ are known in the market before official notification. Investors should be aware that news leaks frequently happen during wartime or dull periods. 

 

What are your thoughts?     

 

 

 

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Head Fake, Unrecognized Opportunity, or a Minsky Moment - Weekly Blog # 788

 

Mike Lipper’s Monday Morning Musings

Head Fake, Unrecognized Opportunity,

 or a Minsky Moment

 

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

  

 

 

Searching For Direction

Because low US stock market transaction volume immediately followed the attainment of a new bull market milestone, the media proclaimed we had entered a so called new “bull market”. I wonder if it is true. I believe it is either a head fake, an unrecognized opportunity, or a Minsky moment.

 

Those of us who have watched or played competitive sports are familiar with a team’s attempt to mis-direct the opposition by using a well-timed head fake to draw the opposition into a perilous position, leaving them out of position to defend against a scoring opportunity. The media proclaimed we entered a new bull market following the S&P 500 exceeding a former high point. The transaction volume since then has been quite low. More to the point from my perspective, the NASDAQ Composite is still 17.6% short of its November 19^th, 2021 peak. The reason this is significant is that for some time the tech laden NASDAQ Composite Index has been the leading performance index.

 

Another interpretation is that it could be an unrecognized switch in performance leadership to the S&P 500. Supporting this view is the proportion of declining stocks vs total stocks traded being considerably lower than it was last week for the NYSE (1.9%) vs the NASDAQ’s (4.6%). Byron Wien is reported to have pointed out that it took 3 years to recognize the market hitting bottom in 1982. There is a similar slow recognition that we have entered a new bull market with a new leadership, which might include financials, transportation, energy, and materials. This could be the reason one of the stocks I own and hold in managed accounts (Berkshire Hathaway) was the leading dollar volume stock traded this week. It is an owner of these kinds of companies.

 

There is a third possibility, the entering of a so-called Minsky moment of a dramatic change. In looking at the movements of the market I look to the expertise of the management of mutual funds. In so doing I look at the data from my old firm, now marching under the banner of the London Stock Exchange Group. In its weekly data through Thursday night, I noted a statistical relationship. In a number of peer-groups the asset weighted performance was materially better than the median performance in the peer groups shown below:

 

        Average 2023 Performance through 6/8/23

Peer Group            Asset Weighted             Median

Large-Cap Growth           13.61%                10.28%

Growth                     14.54%                10.36%

Global                      8.47%                 6.52%

 

There are probably two reasons for the consistent gap between the weighted and median performance. The first is the substantial holding of at least 6 of the 10 biggest stocks in the larger funds in the peer groups. Second, the absence of floor specialists and trading capital on major trading desks has impacted liquidity.

 

If we are entering a Minsky moment it is conceivable that leadership could change dramatically from large to smaller market capitalization stocks. Just this week the leading mainstream peer group was Small-Cap Value, which on average was up +7.31% compared to +3.23% for all stock funds.

 

Other Considerations

1.  One of my worries about the current period is that the gains have tended to be small. The problem with small gains is that errors or other problems can wipe them out unexpectedly. During the first quarter the S&P 500 essentially broke even. More frightening is that analyst project a decline of -5.4% in the 2^nd quarter. They expect a 3^rd quarter a recovery of +1.7%, with a +9.0% gain in the 4^th quarter. Considering the number of errors reported in many sectors and companies, I fear these mistakes may wipe out many of these numbers.

 

In the past many of these mistakes would have been caught by supervisors. Unfortunately, many supervisors have voluntarily left or have been pressured to leave. Some misguided managements see the lower compensation paid to younger workers as improving margins. However, the higher margins don’t consider the inexperience of the new workers. Some managements prefer inexperienced workers who do not bring up delaying cautions. (We see this on some trading desks.) While employees who switch jobs often get twice their normal compensation raises, these pay increases are now declining at twice the rate of the increase paid for workers to stay.

                                                                                             

2.  Regardless of whether an investor owns a Chinese stock, he/she is impacted by the second largest global economy as a consumer of low-priced imports from China or as an employee of an exporter to China. To the extent the US restricts its dealings with China for political reasons, other countries may choose not to.

 

We invest globally, both in terms of making money for our accounts and also to hedge some of our domestic investments by owning some Chinese stocks competing against China. At this point in time, I believe every American should follow activities in China.

 

Headlines from China

1. The substantial unemployment in the 16-24 age group. I suspect many of them are better educated and disciplined than our own youths who don’t have similar attributes.
2. Second and related is the expressed view of the Chinese equivalent of our Secretary of Defense who said that a war with the US would be disastrous for them. This removes the European approach to people out of work.

3.  People at the top of the US financial ladder have some of the best investment and tax advice money can buy. I find it instructive that the top 0.1% have substantial amounts invested in haven partnerships and individual haven securities. The next 10% have very little in haven partnerships, but a lot in individual haven companies. I suspect those at the very top are concerned about preserving their wealth for others. While they fear inflation, they are more concerned about taxes. Perhaps we should be thinking long-term?

 

 

 

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3 PROBLEM TOPICS: Current Market, Portfolios, and Ukraine- Weekly Blog # 779

 

Mike Lipper’s Monday Morning Musings

3 PROBLEM TOPICS:

Current Market, Portfolios, and Ukraine

 

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

 

 

 

Current US Stock Market

The views and focus of pundits can be very misleading. Below is a list of some of them and my contrary thoughts for you to consider and react to. In no particular order:

1. The narrow performance premium of stocks over bonds is “ugly”. (To the contrary, it may be a good entry point. Over any reasonable investment period one could envisage a 100% - 1000% gain for equities and/or equity funds. I doubt one could see that in bonds.)
2. The recent announcement of the number of people hired was “bullish”. (Within the release there was the note stating that the number of hours worked declined. When business is bad it is normal for a company to announce cuts in costs before a large layoff. This announcement was for a given middle week in April. At about the same time the NFIB Small Business Hiring Plans Index announced a 15% decline for March (small businesses employ over half of working Americans). The NFIB also showed a widening gap in the number of hours worked between the rank-and-file employees and all others. This may show that businesses can’t find entry level workers wanting to work. Another factor could be the better weather in March and April relative to the first two months. This suggests the rise reported for April was more weather related than from improving business conditions.
3. Almost 90% of the first quarter’s gain came from just 20 stocks. UBS noted that if mega cap growth stocks were deducted from the index, the remaining stocks would only have gained 1.4%. (New “bull markets” are not normally led by the leaders of the last up market. Currently, Large-Cap Growth funds are leading, and small-cap value funds lagging - Tech vs Financial Services.)
4. While the interest spread between two and ten-year Treasuries has narrowed very rapidly to 530 basis points, from 1400 recently. It raises the question of whether the inversion is going to precede a significant recession. The weekly survey of the American Association of Individual Investors (AAII) is often considered a contrary measure by market analysts. In three weeks, the bearish prediction fell 13% points to 35%, with the bullish reading gaining 12% points to 33%. These numbers show how volatile the individual investor is, but it also shows that the bulls have not built a base for a higher market at this moment. (I disagree with the opinion of many professionals that the public is always wrong. I believe that they are mostly wrong at turning points, but generally right over the long-term.)
5. In a period like we are in now, the twin absence of trading capital in the hands of the former floor Specialists and “upstairs” traders is having a significant impact on the security selection of investors. (Look at the declining average performance of mutual funds in the first quarter: Large-Cap Funds +6.71%, Multi-Cap Funds +5.11%, Mid- Cap Funds +1.78%, and Small-Cap Funds +0.50%. This rank order is the reverse leadership position of many past bull markets.
6. The term “book value” should only be used by accountants, never in front of unsuspecting investors. Book value has nothing to do with either useful books or value. It is an accounting term to spread the remaining non written off purchase price recorded on the balance sheet. It has nothing to do with the liquidating value of an asset, or what a knowledgeable unrelated person would pay for the asset. The present or future value of an asset might be of interest to a potential buyer if it is sufficiently discounted for the trouble and bother of actually receiving the assets and liquidating it. 

Constructing Portfolios

With the exception of an entrepreneur singularly focused on a business that it close in value to the total of its assets, the assembly and management of investor money in portfolios is the real art of investing, not buying and selling individual securities.

Most individual investors and some institutions mechanically add and subtract securities from a portfolio. Most others have a single portfolio with some focus or general need. (I believe one should have multiple portfolios rather than just a collection of securities.) Each portfolio should have a narrow focus, often built around the timing and execution of the beneficiary’s needs. I use singular rather than plural terms, even if the timing and cost of the same security is different between accounts. (It could generate significant impact and therefore could be managed differently.)

The biggest mistake most people make is measuring success based solely on the calendar year, because it’s what everyone else does. (I believe accounts should be measured based on the first reasonable date assets will be paid out. There are also other issues to consider, such as the number and extent of down results compared to up results. As the market moves up and down in its own periods the measurement period should likewise be adjusted. To the extent possible, after-tax returns are preferable. If you buy the same security at different prices, each tranche should be measured separately, especially if the price is quite different. Buying a great security late in its rise rather than at the beginning impacts the results of beneficiaries. While the security may be the same, its intended purpose could be different.

I sit on a number of tax-exempt investment committees and try to get my fellow trustees to pick individual measurement periods. If a stream of payments is required for building a new facility, I suggest making the end date slightly before the first payment date, changing that date based on schedule. For annual operating funds, I use the same concept, but with much smaller time periods.

Finally, where possible I like to pick selected mutual funds having similar portfolio characteristics whose management sticks to policies that can responsibly be followed.

 

Ukraine is Just the Beginning, Not the End

We are all horrified by the cruel invasion of Ukraine. We wish the war would end, with the country’s full land being restored. Unfortunately, I believe we will be involved with Ukraine for many years, possibly generations. The unhappy reason for such a fearful statement comes to us from logistics management.

Just like Political “Science” courses, Securities Analysis is taught about the past and briefly hints at the present. One of the main tenants of sound business practice is building reasonable defenses against future problems. One of the largest potential problems facing businesses and countries can be summed up by the change of “Just in Time” production and delivery to “Just in Case”. Until very recently, businesses located the production of critical supplies where it was the cheapest to produce and where rapid transportation could ship goods and services to major customers.

The rise in tensions with China and some other locations has caused the US and others to review from where they will get their critical products and services. While China should not be ignored as either a source of goods or a market for sales. If either were drastically reduced or totally stopped, we would be in serious economic trouble. Currently, there is a mad dash to find supplemental sources of both production and sales. Other Asian countries are being examined, as are Mexico, other Latin American countries, and Africa, among others.

One very rich region I fully expect to play a role is Central Asia. This region contains Kazakhstan, Kyrgyz Republic, Tajikistan, Uzbekistan, and Turkmenistan. In addition to supplying the critical rail thruway for China’s “Belt and Road”, the region provides the new Silk Road to connect China’s vast population and resources to Western Europe. The region consists of 61 million people and 1.5 million square miles. With both Russia and China as neighbors, this is an important piece of real estate. Permitting a US Air Base in the region would solve lots of problems in opening up Central Asia. It would provide access through the Caspian Sea and reinforce Ukraine’s interest in the Black Sea. While this will be an expensive addition to accommodate our needs, my guess is we will be there.                                   

 

 

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