What is the NASDAQ Saying to Whom? - Weekly Blog # 649

 

Mike Lipper’s Monday Morning Musings

What is the NASDAQ Saying to Whom?

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

Prior to Friday, the performance of the NASDAQ Composite Index led all other stock price indices in performance, and in my opinion, was an indicator of the future direction of the more diversified market.

Then on Friday we experienced an October surprise. The President of the US, the most prominent media political personality in the world, was diagnosed as having contracted COVID-19. An “October Surprise” has been a feature of American presidential politics and some believe it changed enough votes to swing elections. One should remember that voters do not take a verified test as to why they voted the way they did at the time of voting. There is some evidence that voters tell pollsters what they believe they want to hear, or who they think will win. Thus, there is no verifiable way to know how any specific individual voted, or why.

Most people responsible for the ownership of common stocks are long-term investors, and although they participate in the parlor game of expressing their view that it motivates their voting, it does not. Thus, the movement of stock prices or indices is not guaranteed to be predictive of voting results.

NASDAQ Against the World

Trading began on Friday after the announcement of the President’s medical condition, sending stock prices down by more than 400 Dow Jones Industrial Average (DJIA) points. Sharply fallen prices brought buyers into the market and by the end of the day the DJIA was down only -0.48%. What alerted me to something potentially signaling a major change was the NASDAQ falling -2.2%. Since reaching their all-time high on September 2nd, the S&P 500 and NASDAQ have been falling. (Remember my warning that due to changes in composition and weighting the DJIA is likely to be less reliable due to its greater tech orientation.) Until some time passes, the S&P 500 will be a more useful than the dollar weighted market indicator. By Friday’s close, the S&P 500 had dropped -6.49% for the month since achieving its high point. Over the same period the NASDAQ fell -8.14%, the difference being Friday’s price movement. Thus, Friday’s bigger decline could be significant.

What Did NASDAQ’s Friday Bigger Drop Signify?

The NASDAQ index is labeled “tech-heavy” and consequently the performance of tech stocks is disproportionately important to its investors. The only two mutual fund investment category averages gaining over 30% through the Thursday year to date period were Precious Metals +35.68% and Global Science & Tech +35.27%. (Five other investment categories were up in excess +20%) 

Someone with an eye on the political statements made by the leading candidates, and more significantly by some other political leaders concerning the large Tech companies, might ponder the implications of Friday’s tech stock price movement. The popular view is that the Democrats would like to see the economic marketing power of the leading tech companies restricted. Is that the reason the “tech heavy” NASDAQ Composite Index declined materially on Friday? (Prior to Friday, the NASDAQ’s decline from its peak was right in line with the fall of S&P 500.) What makes this view curious is that most CEOs of Tech companies are major Democrat supporters. (It is not unusual for successful candidates, upon being elected, to turn on their supporters and attempt to broaden their mandate.)

Changes in Marketplace Structure Could Be More Important Than NASDAQ Price Movements

While most investors only pay attention to the movement of the prices of their stocks, I also focus on the “inside baseball”. Who is executing and initiating the orders and how their marketing efforts are influencing what we think about their investments. It is interesting that there is rising concern over the marketing power of major tech companies, while there seems to be a parallel concern in the investment marketplace. Recently, it was noted that the five largest asset managers, in aggregate, manage more dollars than attributed to the US GDP. Even greater concentration was indicated by two announcements this week.

Wilshire Associates, a data supplier and asset manager, was sold to two private equity managers willing to provide more capital to expand Wilshire’s business. Also this week, Trian Fund Management announced that they have taken a 9.9% position in both Invesco and Janus Henderson, and announced that there should be greater merger & acquisition activity in the investment management business. These smart people were successful with their investment in Legg Mason, generating a gain of 55% for them. This area is of great interest to me, as I manage a private fund invested in Financial Services stocks.

Did you miss my blog last week? Click here to read.

https://mikelipper.blogspot.com/2020/09/there-is-incredible-shortage-weekly.html

https://mikelipper.blogspot.com/2020/09/headlines-excite-dictate-or-respond-not.html

https://mikelipper.blogspot.com/2020/09/mike-lippers-monday-morning-musings-who.html

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When the Stock Market Sleeps - I Get Nervous

Not only have the popular US stock market averages been flat for a period of twelve years, the recorded volume this summer has been scant. The so-called fear index, the VIX measure, is producing returns significantly below averages. 

In another sign of lack of concern, the decision was made at a recent investment committee I attended that a specific inflation defensive fund was not needed. (If you believe the US government’s statistics, the latest available all items count would be a minus -0.16% for the month of May and a core rate of 0.01%).

Somewhat more ominously there was praise for our committee’s market index fund selection, with the question as to why we should pay the high fees for hedge funds that are not producing better-than-market results. In another investment committee meeting it was suggested that many institutions are buying hedge funds directly and redeeming funds of hedge funds. (If the latter approach gains momentum it can hurt the expansion plans for the number two profit contributor to Legg Mason, a holding in our private financial services fund.)

What makes me nervous is that there are lots of facts and opinions that are crying out for significant changes in portfolios.

Start with the negatives

A recent piece by Moody’s* chief economist, John Lonski entitled “Global Slowdown Menaces Ratings,” focused on the recent plurality of downgrades as opposed to upgrades both for High Yield and Investment Grade bonds. As reported in my previous blogs, the appetite for yield at the moment appears to be insatiable. In the current quarter there have been 43 downgrades and 20 upgrades of high yields, and a 13 to 3 ratio for investment grade paper. Remember that one of the criticisms of the credit rating agencies (for understandable reasons) is that their findings are late relative to the market. The sellers and buyers of bond funds, particularly of high yields, do not appear to be following the changes in ratings. As an equity analyst I have been trained to think that the bond market senses trends before the stock market. The ultimate payoff with bonds is the return of principal with interest, as distinct from the equity market’s hope of future capital appreciation.

*Moody’s is another holding in my private financial services fund.

In one of John Mauldin’s well-written weekly letters he suggests that we may be approaching a Minsky moment. Hyman Minsky, a well-known European economist stated that stability leads to instability. After a period where the normal is flat, there will be a violent change. The key to this thinking is that something will dramatically change people’s views as to when the current supply and demand mix will abruptly change, which is easy to believe in our 24 hour news cycle world.   

In another letter John Mauldin mentions that the real problem for the euro long-term is France, which I have felt to be the case even before the last unfortunate election

One of the advantages to investors of the flat performance of the VIX futures, particularly if we do experience a Minsky moment, is that hopefully both the academics and the marketers will stop using volatility as a measure of risk. To me, risk is the inability to meet future payment goals for an investment or portfolio, not whether the return is calm or fluctuates. This belief can be a problem for the sleep patterns of trustees.

The positives that no one believes

If you ask most people about the progress of the market in 2012, they will say they don’t believe that we are up low double digit returns by mid-August. These returns would more than fulfill the annual requirements of most institutional funds; as a matter of fact the returns are close to double the needed returns for the more sensible institutions.

Richard Bernstein, now independent from a career at Merrill Lynch suggests that Bull Markets begin out of a malaise of fear. Investors are fearful of facing an unpopular election in the US as well other unpopular and unknown changes in governments for over half of the world’s GDP. In addition, the so-called “fiscal cliff” comes due to challenge the US at the end of 2012.

There are no apparent signs of valuations which are historically too high. (I would suggest that the excesses are in the bond market where the manipulating central banks are depressing interest rates. As we know, eventually even the manipulators run out of money.)

One of the more bullish pieces that I have read is by Seth Masters of Alliance Bernstein. In his view of a normal market expansion he sees a Dow Jones Industrial Average of 20,000 in five years. Even on a lower multiple basis, Masters predicts the market will reach this level in ten years. What is significant about this piece is first that it is coming out now in a period of malaise, second it is not from a promoter, or a Dow at 38,000 proponent,  etc., and third, if true a move from here to a 20,000 DJIA would fulfill lots of investment requirements. (As long as inflation remains tame.)

Perhaps the single most bullish piece that came out this weekend was the disclosure of the portfolios of Paul Ryan and his wife Janna. I do not know who selected the list of well-known and generally sound mutual funds. What is significant to me is that the potential “second family” of the US has been well advised and has a spread of funds that are appropriate for the current world. If Mr. Ryan becomes the Vice President or stays as chair of the House Budget Committee, we will have someone in a high place that has a sound outlook for his and hopefully the country’s investments.

Sleep well, but not too well.

Corrections
 In last week’s blog I mentioned a recent study of one account that we manage and said that there was not a single decline in 2012 through July, in the list of 47 funds. The actual number was 37. My apologies for the error. 

Second, for an unexplained reason some of our email readers received a version with the initial letters of some words doubled. If that happens again please let me know and we will send out a corrected copy. 

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On Building Effective Investment Committees

Investment committees are the heart and soul of many non-profit organizations. The deliberations of these groups determine the near term and perhaps the long term ability of the organizations to accomplish their missions. Combined with the organizations’ Development (fund-raising) efforts, the scope of near term activities is determined. In an ideal world, investment should focus on the long term. In the real world, from a pure investment viewpoint, the pressure of near term funding needs often get more attention than warranted.

Currently, I have multi-faceted relations with several investment committees. I chair two very different investment committees, act as a consultant to some and an investment manager to others. Thus, I read with great interest an excellent seventeen page piece on investment committees by Michael Mauboussin of Legg Mason Capital Management. In his summary, he highlights twenty-one thoughts broken down into general findings, advice for committee members, and advice for committee chairs. With due regard for the patience of blog readers I will not discuss each of his excellent points, but will focus only on a handful.

The best committees are made up of members who bring different points of view from their varied experiences and thought patterns. In effect, intense discussions are the mother’s milk of a successful committee. As distinct from a reporting function which dwells on the past that can not be changed, the committee should focus on the future. Important in the deliberations should be the recognition that after exceptional performance, good or bad, the odds favor a reversal of relative, if not absolute performance. Along this line of thinking, the committee should challenge the obvious. One way to do this is for each member of the group to come to the meeting with thoughts that they share about what could go wrong. Before one can properly come to an assessment of investment risk, one should identify what could go wrong. Up to two years ago, there was no discussion of “hundred year storms,” which actually happen much more frequently. ( For those who are interested, I would be happy to discuss the similarities between the market collapse of 1987 and the defeat of the Spanish Armada.)

Perhaps the biggest contribution to increasing the success of investment committees is to record the essence of the discussions that lead to decisions. Subtly, these records can lead to a shift from an exclusive focus on outcomes to lessons gained from the process. We need to recognize that many outcomes are more a function of luck than skilled judgments. However, if our process allows for luck, or if you prefer the unexpected, we are more likely to be the beneficiary of change than those that have a high degree of certainty.

In applying the last thoughts, maybe we should spend time looking at funds that are currently performing badly, particularly those with managers that have been successful a number of times in the past. Will their successes be repeated?

What do you think?