Sentiment Appears to be Changing - Weekly Blog # 689

 

Mike Lipper’s Monday Morning Musings

Sentiment Appears to be Changing

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

Where are We?

In theory, securities markets discount “the future”. We are comfortable believing we “know” where we are going, which is a useful charade because we really don’t know, partially because we don’t know where we currently are. We are bombarded with up to the nanosecond prices, which only tell us about transactions occurring for unknown or appreciated reasons. Far too many investors give convenient reasons for price moves without looking at the underlying data. For example:

• In this past four-day week, down day share volume was higher than up-day share volume. There are three possible reasons for this:

1. With light overall volume, normal liquidations counted for more.

2. Lower prices brought “buy the dip” traders in.

3. Possible recognition the next 12 months wont produce from the bottom type gains.

• The industrial price index tracked each week declined a bit, suggesting the intensity of the inflationary drive is lessening. 

• Performance leadership was too diverse. For June, the 3 best mutual fund peer groups were Natural Resources +13.5%, Latin America +12.4%, and Real Estate +11.3%. (We can discuss off-line with subscribers.)

There was however a performance change that generated a lot of comments by pundits, as well as a few calls to me seeking an explanation for the good June Large-Cap Growth Funds performance of+5.63%, way above the Small-Cap Growth Funds return of +3.68% and the Large-Cap Value Fund return of -0.99%. Large-Cap Value funds beat Large-Cap Growth Funds in the first quarter with returns of +11.05% and +1.57%, respectively. 

On average, stocks in “value” funds have materially lower price/earnings ratios than “growth” funds. The justification for the higher growth fund p/e is that they produce higher earnings. However, they also appear to be more predictable, allowing investors to believe they can extrapolate those earnings for a longer time. Many “value” funds have significant cyclical characteristics and economic cycles are typically of shorter duration than the perceived length of growth. Thus, one interpretation of the switch back to growth leadership is the cyclical peaking of economics favoring value in the second quarter, which will probably contract in future periods.

Outlooks

Remembering my absolute right to be wrong, I searched for clues to the unknown future in 3 buckets: economic data, structure of the American securities markets, and policy pronouncements. From my standpoint it is not important you believe these views and perhaps act on them, but it is important you are aware of them in forming your own views. There is some chance I may be correct, at least in part.

Economic Data Points

Most of the US and much of the Developed World are emerging from the “lockdown” phase with the realization that aggregate financial wealth has grown through the price appreciation of homes and marketable securities. (It is too early to know the size of the expected loses and hopefully lessons learned by new investors.) What is known from recent government statistics is housing costs have risen to over 30% as a percentage of income. Some of the increase is perhaps offset by a temporary reduction in commuting and office clothing costs. In the past, housing and commuting costs were expected to be below 25% of income. The diverted income probably came from the portion not going into investments, which was intended to be used for debt repayment,  retirement, and schooling costs. Because of the appreciation in the cost to buy a home, renting has become more popular. The problem is that there is no opportunity for capital growth, so there’s a good chance that investing for retirement will lessen and the age of retirement will lengthen.

Much is being written about the inevitable risk of rising inflation. Although most of the focus is a future number, the danger from rising inflation is how it will influence the spending habits of individuals. In looking at major future expenditures, people will either accelerate purchases to avoid future price rises, delay purchases until prices drop, or wont purchase the products or services. All choices will be somewhat negative for long-term economic growth. The key to inflation expectations are whether they extrapolate present levels or anticipate a material change in the rate of inflation. Recent surveys of inflation expectations broken down by the age of the predictor are insightful.

Inflation Expectations

Age Group  Expectation  Contribution to Economy

Under 40       3.2%           Net Spenders

40-60          4.0%           Net Savers

60+            4.6%           De accumulators

If there are not habit changes and the absence of negative changes, these projections could be low. (In the past, savings did not accelerate unless savers received at least 2% above inflation, or a minimum of 4%. The gates my not open widely below 5%.)

Market Structure

While the US’s share of global GDP is 16%, our share of global market capital is 44%. While there is some logic that US GDP will grow in absolute terms, its share of market capital is likely to decline. One reason is that we have made being a public company unattractive. The 2000 largest public companies listed by Russell shows 499 being growth stocks and 842 being value stocks. MSCI can only find 434 European companies to track and 1547 companies in the Asia Pacific. To provide the necessary retirement income, US and European investors must invest beyond their borders and probably beyond their governments.

Even during a week where growth outshone value, investors in NASDAQ stocks were far less bullish than those on the New York Stock Exchange, measured by the ratio of new highs to new lows: 

         New Highs vs New Lows

NYSE           380 vs 90

NASDAQ         287 vs 220

Policies

 Almost always it is risky to take politicians’ words at face value, they show what the public wants to hear but not their real intent. With the current administration we have some pretty good clues as to their model. One unmistakable clue is the return of the Franklin Delano Roosevelt bust to the oval office. The stated goals of the current tenant are close to a carbon copy of FDR’s second term, which needed WWII to bail the country out from its socialist policies.

I can email the “Executive Order on Promoting Competition in the American Economy” (29 pages, plus 48 pages of a fact sheet) if anyone cares to see it. One should understand that these documents are written by lawyers with little or no business and/or investment experience. 

Working Conclusion

We have entered a new phase that is unlikely to benefit from the strong tail winds that peaked in the second quarter. For those that are prudent, there are signs of potential stock and economic trouble ahead. As with the study of what causes wars, there are both underlying and immediate causes. In terms of the battle for investment survival, there are cracks in the foundation of the investment structure. (This is not an intended reference to the collapsed 40-year-old condo.)  There is not yet a visible immediate cause for a meaningful decline. (Assassination of the Crown Prince, the immediate cause for troop movement in World War I.) Consequently, prudent investors should adopt a trading approach for their short-term oriented funds and be prepared to increase their long-term positions at lower prices.

       

        

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

https://mikelipper.blogspot.com/2021/07/independence-day-3-investor-lenses.html

https://mikelipper.blogspot.com/2021/06/what-did-fridays-market-political.html

https://mikelipper.blogspot.com/2021/06/mike-lippers-monday-morning-musings-50.html

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An Awkward Moment with Frustration not Exhaustion - Weekly Blog # 591

Mike Lipper’s Monday Morning Musings

An Awkward Moment with Frustration not Exhaustion

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

Trying to develop a sound long-term investment strategy at any time is difficult, as most of the time we are clearly not at a top or bottom of a significant market move. We wander along an uncertain path to an eventual turning point, but each day, or in my case week, I must read the current sign posts to decide whether or not to change direction on the path I am traveling. Currently, there are three difficult choices to select from:

1. Stay reasonably fully invested in the upward sloping secular trend, accepting that there will be periodic cyclical movements.
2. As the opportunities and risks in today’s world are not the same as in the past. We should become increasingly defensive by building meaningful cash reserves.
3. Prepare for global policy mistakes that causes devastation.

I put the chances of being correct for each of these choices at 65%, 30% and 5%, respectively. On an overall basis I would improve my odds by sub-dividing the portfolio into timespan segments and periodically re-weight the commitments to the segments based on both perceived future conditions and the changing needs of the beneficiaries.

These three working conclusions are based on the following inputs:

Secular Continuation with Bouts of Cyclicality

• Most of the current volume is being generated by those that have a short-term time horizon. They are being whip-sawed by politically oriented news which is generating a lot of frustration. However, it is not generating the quantity of transactions representative of final exhaustion, or a complete retreat from participation.
• Nevertheless, traders are making decisions based on liquidity e.g. compare the ratios of advances to declines on the NASDAQ 211/314 vs. NYSE 411/229. (In general stocks on the NYSE trade in greater volume than on the NASDAQ) 
• Net flows into and out of ETFs shows short-term withdrawals this week. The two largest withdrawals totaled $4.6 Billion and the two largest net purchases totaled $1.2 Billion. The S&P 500 and MSCI Emerging Markets were sold and Consumer Staples and Gold were bought. 
• Even after Friday’s drop of 3% for the NASDAQ it is till up +16.63%, whereas the DJIA is up only +9.87%. Both gains will probably be larger than the total earnings gains for 2019, suggesting the market is looking for a good 2020.

Game Changers

• Lower interest rates and less binding loan covenants are likely to cause more bad loans.
• Only 42% of weekly prices are rising. Could we have deflation in goods and inflation in services and imported goods?
• Last week the interest rate offered to depositors went from 0.65% to 0.73%, suggesting that banks are increasing lending in face of slowing demand for products and services.

Global Mistakes

• The battle for dominance is essentially driven by defensive needs, not land or market dominance.
• The Chinese have been thinking in these terms for more than a thousand years. The earliest example of their well-developed thinking is in the writings of Sun Tzu entitled “The Art of War”. Jessica Hagy has produced a book that visualizes Sun Tzu’s thoughts. These should be understood by other world leaders and are shown below:
• Hold out baits to entice the enemy
• Feign disorder and crush them
• If your enemy is secure at all points, be prepared for him. If he is in superior strength, evade him.
• If your opponent is temperamental, seek to irritate him. Pretend to be weak, that he may grow arrogant.
• If he is taking his ease, give him no rest. If his forces are united, separate them.
• Attack him where he is unprepared, appear where you are not expected.
• These military devices, leading to victory, must not be divulged beforehand.
• The general who wins battles makes many calculations before a battle is fought.
• The general who loses a battle make but few calculations before-hand.

The Asia Times has an article entitled “China now has edge in Indio-Pacific”. It is based on a think tank report from an Australian group named United States Studies Centre. The study raises the question “Could the era of US military primacy in the Pacific be over? Their view is that internal conditions within the US suggests that it will not fully fund the needs of its National Defense Strategy. At the same time China is building a capability which in a surprise attack would destroy or cripple some or all of the US’s Western Pacific main installations in Guam and Japan. (Interesting that the report did not name our forces on Iwo Jima and in the Indian Ocean.)

My Point of View
As a former electronics, aerospace, broadcasting and conglomerates analyst, I have seen the power of small electronic components change massive companies and markets. The current “trade war” was designed to protect the primacy of our semiconductor technology, which is critical to both US and Chinese defense efforts. To paraphrase Admiral Alfred Thayer Mahan’s statement of Who controls the Seas, controls the world. I believe the two Emperors of China and the US are acting as Who controls (leads) semiconductors and related technology controls the defense of their countries.

An Important Question
Considering how long value focused managers have suffered, can we build portfolios that are able to survive a similar period, regardless of our investment strategy? Any thoughts?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/08/short-term-recognitions-plus-longer.html

https://mikelipper.blogspot.com/2019/08/sentiments-approaching-reversal-points.html

https://mikelipper.blogspot.com/2019/08/is-last-week-significant-weekly-blog-588.html



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A. Michael Lipper, CFA

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How to Survive Banner Headlines

Introduction

Investors and the public in general tend to believe in big headlines and invest in the direction of the headlines. Often this is a mistake. On the front page of The Wall Street Journal last week there was a five column banner headline trumpeting “Broad Gains Power Historic Rally.” A sub headline stated that for the first time since 1993 that six closely watched indexes rose in the first half of the year. (The indexes were two from Dow Jones - DJIA and Commodities; two from MSCI - World Stocks and Emerging Markets Stocks;  as well as indexes for Gold and Bonds.)

The financially sound investor would quickly point out that the flow into tradable elements was caused by people getting out of cash money. Institutions and individuals were recognizing that excessive borrowing to meet or prolong deficits and the central banks manipulating interest rates has caused a twenty year recognition that in today’s world cash is trash.

Those of us who have any knowledge of how people (particularly investors and voters) react will recognize that when there is a large imbalance of opinion that the majority will win for a relatively short while to be followed by major disappointments. Such may well be the case this time.

How do I know? Years ago I learned from a very sound investor who happened to be one of my accounting professors that I should read financial statements from the back forward. I should spend as much time reading the footnotes and auditor’s certificate as I would in reading the CEO’s comments even though the CEO’s comments were designed to be more easily understood. I suggest that all who wish to be informed and to have the ability to change one’s views to read the small articles at the end of the pages in most newspapers. If you do you might come up with what I am seeing.

Bits of information important to me

1.      In the last week the average interest rate paid on bank deposit accounts (MMDA) went from 0.37% to 0.43%. In most weeks there is no change or only minor moves of .01%. This 16% move could be for some technical reason or could be that banks, mostly retail banks, are starting to make loans and need more deposits.

2.      The five month increase in CCC (low credit quality) loans is up 17.2%.  At the same time there was a decrease in high quality loans being sold.

3.      Moody’s ^* is concerned that the combination of below trend profit growth and above trend borrowing will lead to an increase in defaults.

4.      Two very respected investors from quite different vantage points, Stephen Roach and Wilbur Ross, are worried about too much easy money. Steve is one of the leading experts on investing in China and Wilbur Ross has had a very successful career investing in distressed securities both in the US and elsewhere.

5.      Bank for International Settlements (BIS) which is the international bank that provides credit to banks globally is warning about “euphoric markets.”

Applying concerns to portfolios

As a professional investment advisor I need to be concerned each day as to how the accounts that I am responsible for are positioned. In almost all cases these accounts must be in the market to meet their long-term needs. Today, with interest rates in the range of perceived long-term inflation, (if not lower, as shown by the WSJ banner headline), the bulk of the accounts are balanced accounts with a preponderance in equities.

Regular readers of these posts have learned that I am worried about a major, once in a generation, drop in equity prices. Up to now I have been focusing on stock prices to generate sell signals. Increasingly I believe I should focus much more attention on fixed-income markets. The triggers to the last major declines were caused by the failure of Lehman Brothers ability to finance itself and the widespread fears of residential mortgage defaults. These were fixed-income problems that severely impacted stock prices.

I want to learn from other investors and investment managers. This is why I prefer in most instances to invest through funds managed by bright people. This week someone sent to me a copy of Schroders^* latest investment letter. In the letter Schroders divides its outlook for the future of its accounts into scenarios. The most probable is an extrapolation of present trends. However, the letter mentions seven other scenarios which could be important. I have listed them in order of their probability according to Schroders:

• Capacity Limits
• G7 boom
• China Hard Landing (Steve Roach believes the increasing codependence on China could hurt the US if we don’t come to a better relationship.)
• Secular Stagnation
• Eurozone Deflation
• Trade War
• Russian Rumble

^*Owned by me personally and/or by the private financial services fund I manage

While each of these could be the problem that sets off the market decline, to me the key is the proportion that Schroders gives to the most probable outcome, the essential “muddle through” scenario which is at 65%.

Why I am limiting equity exposure

Coincidentally because of my concerns after five good market years and below average economic years, I think it would be wise to limit equity exposure in a conservative balanced account to 65%. While I expect we could have one more major, almost skyrocket selected stock price move, I would be moving lower in terms of equities, if I could find some reasonably safe fixed-income alternatives producing above inflation rates of return.

The equity exposure mentioned is for those accounts that will have funding responsibilities in the next five years. Longer-term accounts could selectively be higher, except I am beginning to worry about long-term endowment type accounts. In the past I felt that this account should be invested all in equities as the best way to get the benefits of disruptive technology and favorable demographics. I am beginning to worry that pricing competition could be too fierce. 

In terms of demographics, I believe that the US will accept more legal and if not illegal immigration. My concern is as to the quality of our young labor force today. I find it disturbing that in the US Army’s reported view, only 29% of the population could be accepted. (I don’t know what the experience is for the US Marines, but we only wanted “the few”). Without the right people our long-term returns will not match our needs.

Please share with me your views.   

__________________

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