Introduction
“Horses
for Course” is a racing expression which indicates that horses run differently
at different racetracks. Not only different courses but different lengths of race.
As is often the case, what is true in the analysis (or handicapping) at the
track is also true in the selection of managers, securities, and investment
strategies. These concepts were the genesis of my developing different timespans
to be used for managing investment portfolios.
In the
first two timespans, Operating and Replenishment, significant financial losses
are difficult to overcome and thus cyclical considerations dominate. The longer
term Endowment and Legacy portfolios assume periodic declines, but that long-term
secular trends will dictate their future performance.
As we
appear to be entering a period of switching gears from complacency or frozen in
place, to one of growing enthusiasm, the prudent investor should increasingly
wonder what could go wrong. Of the myriad of possible future events it is
unlikely that one can accurately predict what will happen. At the current time
I feel an obligation to point out possible unanticipated problems.
I will
first focus on possible cyclical problems that can impact investment
performance through an intermediary period of roughly five years and thus
cyclical factors. In the second part of today’s blog I will focus on Asian,
African, and Latin American factors that could impact the longer term secular
trends.
Cyclical Factors for the Intermediate Term
As
Professor Robert Shiller points out, almost everyone acknowledges that a
recession will happen. He further states at the moment that not too many
investors are concerned about a future recession. The popular securities
indices are regularly reporting new high levels. However, the best performing
of the three indices, Dow Jones Industrial Average (DJIA), Standard &
Poor’s 500 (S&P500) and the NASDAQ Composite (NASDAQ) is the last one by
a considerable margin, as small companies particularly those involved with
information technology including Apple* performed well.
While the NASDAQ is slightly reporting new highs, it is not demonstrating a
major breakout after hitting a new high and thus it may be questioning the
strength of the move. This is not particularly upsetting because as in the past,
Apple shares sell off after new product announcement run ups. As a long-term
owner of these shares I am much more focused to see the level of sales and
deliveries in its fiscal second quarter ending in March 2018. While some market
rotation is healthy if it does not include a strong NASDAQ performance, it
would be demonstrating the “animal spirits” are getting tired.
*Held personally
Market
leadership rotation is normal and expected, but when one or more of five
sectors or asset classes lead, it will be an indication that investors are
deserting the central forces of the economy. If you possess trading skills the
five sectors could be very productive. If you are like the most of us who move
in and out late, be very careful. The five in alphabetical order are Bonds,
Commodities, Energy, Gold, and TIPS. If you are an accomplished player, play.
If not it would be time to build reserves, particularly if you are managing a
current or replenishment account.
As
mentioned last week the gains in earnings being reported for the first half of
2017 are due to expanding profit margins. Earnings per share are growing faster
than revenues which are growing slowly and in some cases very slowly in the
second quarter. To create sustainable earnings and employment we need to see
revenue generation pick up.
The
potential expansion in the level of enthusiasm for stocks may be heralded by
the decline in neutral sentiment in the latest AAII survey, dropping from 36.7% last week to 32.7% this
week, and a roughly similar increase in bearish attitudes. This suggests to me
we can see an important increase in volume which in and itself engenders more
volatility.
My
real concern for the intermediate future centers around the bond market which
is larger than the stock market but can be much more sensitive to short-term
events. I don’t know what can create a bond market bear market, but the
following are thoughts that needs to be understood:
·
The little understood bank for central banks, the Bank for
International Settlements, has noted that many governments, including the US, are
only identifying contingent liabilities in their financial statements. These include
unfounded pension and medical costs. One potential concern of mine is a large
size of unprofitable investments by China in building its One Belt One Road
Initiative (OBORI) in neighboring and other Asian countries.
·
Yields on high grade corporate bonds are rising which means
prices are falling slightly, showing some lack of demand. At the same time yields
on lesser quality bonds are holding up, showing an increase in demand.
·
Just as yields go in the opposite direction, the contrarian
in me suggests that flows follow performance late
and stay too long. In almost every country that has a mutual
fund business there is an increase of substantial size in the
flow into bonds. They are easy to sell to people in view of the
low manipulated rates dictated by central banks that impact commercial
banks’ deposit rates. This excessive flow is augmented by the large number of
financial groups offering new credit funds without sufficient experience in
non-bank lending.
In sum, I grow increasingly wary in crowded
markets.
For
the intermediate term investor I see more performance/career risk than we have
seen in sometime. Perhaps, we will escape but by the next US Presidential
Election the odds are that we are going to be tested.
Secular Concerns for Longer Term Investing
For only long-term
investors to consider in their third (Endowment Timespan) and their fourth
(Legacy Timespan) portfolios are some surprising inputs from a two day visit to
Mumbai, India. To fulfill two speaking engagements at a very busy time of year,
my wife and I flew into Mumbai Thursday night and left on a redeye Saturday
night. The purpose of the two speeches was to have discussions with Indian
mutual fund CEOs, portfolio managers, independent investment advisors and
distributors of funds. There are forty fund houses with thirty four reporting
their net asset value in the paper. I made the point that they have only
penetrated 3% of the households where in the US the penetration is over 40%. In
addition to focusing on mutual funds, I had hoped to find some good long-term
investments for our family accounts. I knew it to be a long shot in that the
Indian stock market for the year to date is the best performing large country
market. I was impressed with the quality of the Indian professionals that
inhabit their market and compete with a relatively small number of foreign
funds that are devoted to investing in India.
As with many adventures
and experiments, there are surprises generating from some disappointments in
the initial objectives. On Saturdays there are two major financial newspapers published in India, (The Economic Times and Financial Express) which have
articles of interest that could impact future investing in India, China,
Africa, Latin
America and other Emerging Markets.
The following are
briefs from the points of views expressed without any additional research or
separate opinion from this traveler:
“Africa Sees India as
Key Growth Partner” is the title to an article that contrasts with the way
India is viewed as compared with China as a source of development spending.
According to the article "Recent media reports have carried allegations
that Chinese business houses are treating African workers as slaves...."
India on the other hand is viewed as a collaborator with the locals. The
article mentions an Indian-Japan-Asia-African Growth corridor as an
alternative to China's One Belt One-Road Initiative (OBORI). Apparently the
Chinese focus is natural resource development for export principally to China.
The Indian-Japanese-Asian effort focuses on rural development and agriculture,
energy, and education. In addition they
are interested in quality of life issues and within the region, connectivity.
This is similar to the development practices that are found also in Latin
America. (India itself is beginning a campaign to improve the lot of its
farmers through the application of technology along with capital.)
The Indian Post
Payments Bank next year expects to equip a large portion of its postmen with
equipment including biometric readers, a debit and credit card reader, plus a
printer. Thus home dwellers will be able to quickly and safely pay various
bills.
"Chinese Government
Plays Cupid to Help Youth Get Married" is an article about 100 million
young people in China that are not married. The government is sponsoring a blind date
service. It specifically suggests that marriage will aid in future
development.
SBI Life this week had an IPO
and produced two interesting details, for this the largest life insurer in
India. The first is the offering was oversubscribed by a 3.58 times ratio led
by institutional buyers. What was of interest to me is that High Net Worth Investors
only utilized 70% of the allocation available to them and retail investors used
just 85%. From my standpoint the most interesting
numbers were that in 2016 the Indian Life Insurance industry penetration was
2.7% and this compares with 7.4% for Korea, 5.5%
in
Singapore, and 3.7% in Thailand.
Can you imagine what
more I could discover if I spent another week, month, or years in India?
Seriously, my very brief visit highlighted to me that investors should not
isolate the impact of single nations in making decisions. China, India, Africa,
and Latin America as well as the rest of the Emerging Counties are linked in
many ways that need to be understood for successful long term investing.
__________
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A. Michael Lipper, CFA
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