Committing Reserves - Weekly Blog # 547

Mike Lipper’s Monday Morning Musings

Committing Reserves

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

Any student of military history will be presented with the reasons why important battles were won and lost. Often the critical decision was when and how reserves were committed, both in defensive and offensive phases. The same thing can be said for managing portfolios. The standard battle structure used by the US Marines for maneuver units is, two up and one back, plus support units. On offense, reserves are committed to replace the tiring front line units so that fresh troops can pick up the pace of an attack. On defense, if the front line forces are pushed back, troops held in reserve are committed to stop the breakthrough, where enemy's troops are expected to be tired and somewhat disorganized. The keys to committing reserves are the factors of time, surprise, and location.

Applying these military lessons to portfolio management, the following principles come to mind:

1. Reserves need to be of sufficient size to maintain or regain the momentum. The two up and one back suggests that reserves should be in the range of 1/3 of the active forces.
2. Reserves should not be committed piecemeal, as they lack sufficient force to accomplish the main objective.
3. Reserves should not be committed too early, suggesting a 25% decline from the prior peak might give sufficient space to pick up bargains.
4. After committing reserves, be prepared to assign additional assets in order to preserve critical resources.

Husbanding Reserves
This week both Goldman Sachs and Morgan Stanley reported unexpectedly good earnings, which the market treated positively. In carefully reading their release and listening to their conference calls, there were some cautionary notes. Both are watching very closely for any weakness in their credit extensions.

Awaiting Direction
Along with other money managers, flows were slower than earlier periods. Modest earnings gains are expected by various analysts. The biggest gains are expected for the Russell 2000, which may be influencing the proportion of firms becoming profitable.

The average Large-Cap growth fund is up +9.09% YTD and +12.72% for five years, with both exceeding the average S&P 500 Index Fund performance of +4.78% and +11.52% respectively. The period of superior performance for index funds may be over for a while.

Major Commitment
Finally, on Thursday there was the announcement of Mass Mutual selling Oppenheimer Funds to Invesco for approximately $5.7 Billion, largely in stock.

In looking at the price, there are two interesting points. First, the rumored price was $5 billion in cash. This is roughly equivalent to $5.7 Billion in stock, in my opinion. Second, the seller wanted to stay invested in the mutual fund business. I view both as a vote of confidence in the business. Invesco has good distribution capabilities in Europe and Asia, which may be effective in selling the Oppenheimer Funds.

 Mass Mutual as a knowledgeable seller becomes the largest shareholder in the combined company and obtains a board position. They like the outlook for the business but probably don’t like the outlook for Oppenheimer’s retail fund operation. Mass Mutual has retained their ownership of Barings, an institutional player.

My clients and I own positions in a number of their domestic and international fund management companies.

Prudential Needs Smaller Reserves
Prudential Insurance is no longer labeled as a SIFI (Strategically Important Financial Institution) It did not have to contort itself as Metropolitan Life did to shed the title, it just had to be more patient and work Washington well.

Risk Management, not a Perfect Defense
Risk appears to be singular but in reality it encompasses a number of known and unknown risks. This multiplicity of risks makes it difficult to model as a single risk factor. This is particularly true due to a growing list of unknown risks. Thus, there is no such thing as a riskless investment.

Some Portfolio Managers Reduce Market Risks
The following brief comments are derived from reading the quarterly institutional reports from T. Rowe Price and Wasatch Funds, that we and our clients own. They are derived  from portfolio managers who also look at broader issues that may be of interest to our subscribers.

1. In the third quarter and continuing into the fourth quarter, security valuations didn’t seem to matter much. High Price/Earnings ratio stocks outperformed those with lower Price/Earnings ratios.
2. Investors remain complacent to the potential of future shocks.
3. A number of portfolio managers are pruning their portfolios by selling into strength.
4. At least one perceptive portfolio manager is taking advantage of the fall in Chinese stocks prices by broadening and deepening her commitment to non-tech Chinese stocks.
5. Concern for the housing outlook favors beneficiaries of short-term and longer-term lower commodity-priced inputs.
6. Trimming some Software-as-a-Service stocks.

In our private financial services fund I personally own shares in the publicly traded T. Rowe Price stock.



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From One Week to Eternity with Reason - Weekly Blog # 543

Mike Lipper’s Monday Morning Musings

From One Week to Eternity with Reason

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

Investors’ Dilemma
“Buy and hold forever” is an easy and dangerous command that investors’ issue to themselves. The one guaranteed aspect of life and investing is that conditions change, often in surprising ways. Because making investment decision is frightening, there is a natural tendency to make as few decisions as possible, recognizing that we might be wrong. This ignores that everyday an action is not taken is a decision in itself. The one sure bet is that the conditions that underlie any decision are likely to change, both for the investor and the investments, be they individuals or institutions.

One way to deal with a big problem is to break it up into a series of smaller problems. That is why I trademarked the TIMESPAN Lipper Portfolios TM. This approach allows the individual and portfolio manager to select the appropriate strategy and tactics for each important time slice. (I would be pleased to discuss this application to subscribers’ own needs.)


Professional Portfolio Managers’ Commercial Dilemma
Professionals are hired to think about and do something with the money entrusted to them. Since thoughts can’t in and of themselves be measured, many investors evaluate their investment advisers solely or largely on the activity of buying and selling in their accounts, when at times it makes more sense to do nothing. (Dividing the long-term records into high and low turnover managers, the low turnover managers tend to produce better investment performance records.)


What to Act on and When?
The key is in the straw, that is the final straw that breaks the camel’s back. The more risk averse among us may prefer to wait to a time closer to the final collapse. Again, both the professional and individual investor should be conscious of impending changes to the investors’ condition.

Evaluating the changing conditions of the underlying investments each week, I peruse lots of hard and soft data in an attempt to understand their implications for the various time spans for which we are responsible. The rest of this blog is devoted to what I looked at in the latest week and why they might have longer term implications. 


Markets

• US stocks appear for the second consecutive year to outperform US Treasuries. This is the longest such period since 1922-28. (Caution warranted)

• The six largest countries (G6) are again spending a smaller portion of their GDP this year than they did in 1948. (We won’t be able to fulfill the population’s demands if we can’t deliver goods, services, and people inexpensively and efficiently. This could be an opportunity.)

• By 2050 the cohort of 65+ will more than triple. (Potentially important for both the real work force and healthcare). Adding to these trends is the likelihood that babies born today will be alive for one hundred years.

• Each week The Wall Street Journal publishes weekly price changes for stock indices, currencies, commodities, and Exchange Traded funds. In the latest week, the top three performers that all rose approximately 7% were commodity related and were down considerably earlier in the year. The next three largest gainers were foreign stock markets that likewise were recovering from earlier declines. (I am wondering how much of these extraordinary gains are from short covering. The general characteristics of the six are sudden/rapid changes in perception, low level of present market liquidity, and the availability of margin to support derivatives.)

• NASDAQ(*) reported that the trader who defaulted on $134 million of derivatives will pay back the default. (This probably reassured the derivative market that we aren’t facing a mini repeat of the Long-Term Capital Management insolvency). 

• There is a published market rumor that Mass Mutual Insurance is selling Oppenheimer Management for approximately $5 billion, which would equate to 2% on assets under management. This would be considered a good price in today’s market. (If the rumor is accurate, the buyer is also in the business and can use some of the investment and marketing talent. Insurance companies have regularly entered and left the mutual fund business. Cross-selling is more difficult to do well, resulting in volatility and risk)

• The Dow Jones Industrial Average and the S&P 500 developed price gaps. Most of the time prices can’t move much until these gaps are filled. (Short-term caution) 

• The market was unexpectedly kind to my examples of the type of stocks that would be suitable for adult children that are not focused on investing (Berkshire Hathaway (*) and those suitable for grandchildren as a long-term change agent BYD (*)  

Bonds

• According to a Barron’s, an index of high-quality corporate bond yields has broken through 4% vs. 3.19% a year ago. According to the perceptive Marcus Ashworth of Bloomberg, this could be caused by there not being enough high-quality European debt to meet the demand in a period when European companies are growing at half the rate of those in the US. In addition, it is expected that for the next several years there will be little to no net new German government issues. (If this is correct there are two likely results. The first is greater demand by Europeans for US debt and second that US companies will issue Euro backed debt. American companies have substantial European operations and sales.)

• The Financial Times devoted a full page to large private equity shops that have become even larger factors in the private debt market. These and other non-bank credit providers have taken significant market share from the traditional bank lenders by employing heavyweight deal makers, thus improving the certainty of closing with less stringent terms (covenant-lite) in exchange for higher interest charges, which in some cases are floating rates. Moody’s (*) has noted that 80% of the currently marketed issues are covenant-lite. Howard Marks is quoted as saying “The seven worst words in the world are: Too much money chasing too few deals.” (If there is an actual or rumored sudden credit market problem involving leverage or derivatives, it is very likely that the stock market will feel it.)

Trade

• The three fastest growing export markets for the US since 2001 are: China 580%, Hong Kong 140%, and Mexico 140%. (In looking at the three leaders I wonder how the transshipment numbers are handled. The whole practice of global supply chains makes looking at national data questionable, at least to me. Are Apple (*) cell phones US, Chinese, Korean, Taiwanese, or Japanese products?

• In 2016 Asia outpaced North America in patent filings by more than 3 to 1. (There is a legitimate question as to the commercial value of some of these patents.)

Mutual Funds

• Utilizing the Lipper Investment Objective Fund Indices for the week ended Thursday, the leading categories were: Precious Metals +4.59%, Global Natural Resource +3.15%, European Funds +2.60%, Financial Services +2.37%, Pacific Region +2.32%, and Emerging Markets Stock funds +2.05%. In each case these categories are recovering from earlier poor performance. Not a single one of these categories beat the S&P 500 Funds Index +10.83% on a year to date basis. Small-Cap Growth +21.48% and Health/Biotech +20.64% almost doubled the market measure, but they are also playing catching up for longer periods of underperformance. (There appears to be much greater selectivity required to come up with a top performing investment objective. This suggest narrowness of leadership, which is more prevalent around peaks.)

• The dominance of very selective ETFs is probably due to a relatively small number of trading organizations like hedge funds or leveraged investment advisors. For example, one ETF drew in more net inflows than all other equity ETFs. The SPDR S&P 500 took in $2.7 billion for the week compared to a total net equity fund inflow of $2 billion. The figures are from my old firm, now a part of Thomson Reuters.

Working Conclusion
There are short-term trading opportunities and after at least a measurable downturn, longer-term opportunities.


(*) A position in these securities are owned in the private Financial Services fund that I manage and/or I own personally.
       

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

Did someone forward you this blog? To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2018

A. Michael Lipper, CFA
All rights reserved

Contact author for limited redistribution permission.