Changing Investment Directions-Different Views - Weekly Blog # 642

 

Mike Lipper’s Monday Morning Musings

Changing Investment Directions-Different Views

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

August Calls

Market analysts have frequently identified August as a month of change in market direction. During a period of normally low volume, a little extra volume in the face of vacations can have a disproportionate impact. In addition, August usually firms up detailed plans for the highest grossing 4th quarter, while preliminary plans for the next calendar year are being finalized prior to final approval. (But we are not living under normal conditions. Thus, I believe it would be wise to adopt a “fan approach” to planning, with at least a high, low and middle ground, to prepare for the probability that there will be rapid changes that require action.)

Because of my professional life experience I start each analysis looking through the mutual fund industry data, which is often a useful clue to both markets and the broader economy. For the week that ended last Thursday night, “Value Funds” gained +2.25% on a weighted average basis. This compares with a tiny loss of -0.02% for the similarly weighted average for “Growth Funds”. Most often the investment trends that occur within the US market also occur in the international markets and this week it was true for both the international funds registered with the SEC and the “offshore” funds we track. Nine value funds were in the 25-best performing mutual funds for the week. Also on that list were five financial sector funds. Overall, financial sector funds gained +3.08%, with industrial sector funds doing slightly better +3.10%. The prior leading sector groupings declined, Science & Technology -1.56% and Global Science & Tech -1.45%. 

While a few weeks of performance does not guaranty a longer-term trend, all longer trends start with a few observations. The stock price moves of value vs. growth are way ahead of changes in the direction of earnings, although they are in parallel with many views expressed by politicians around the world.

China Pulling Ahead

Despite the rising level of tensions between the US and China, it appears on the surface that the trends within China are improving. One of the ways I follow what is happening in China is by reading the research provided by the fund management group, Matthews Asia. The following brief points were derived from their research.

• There were no COVID deaths in China in the first 12 days of August.
• Auto sales are improving on a broad scale in China, particularly for foreign brands. In July, Toyota increased +19.1 % (including Lexus +38.6%), Honda +19.1%, Nissan +11.6%. General Motors sold more cars in China than in the US.
• Last year, 60% of China’s GDP growth came from internal consumption, with only 17% of GDP being gross exports and only 17% of that going to the US. While the US and most of the rest of the world have problems with the policies and activities of the Chinese, we cannot realistically isolate them. We need to come to some accommodation with them for us all to grow.

The “Sage of Omaha” Throws Curves

Warren Buffett for many years threw out the first pitch for the local baseball team. In the second quarter of 2020 he threw a curve ball to investors with his second quarter transactions. Even if our clients or personal accounts did not own shares in Berkshire Hathaway, we would still study the company’s financials and/or pronouncements. I have suggested that a well-constructed financial and business graduate course could be conducted using only their documents. Their successes are legendary, but their few errors are even more valuable as teaching moments. Last week they published their 10-Q report and their second quarter publicly traded securities portfolio with the SEC. Each is worthy of detailed study.

The 10-Q reveals that the company should not be compared to either an open-end or closed-end fund, as it is intelligently leveraged with borrowed money in the form of debt and potential future payments, using customer float and future tax payments. Offsetting the leverage are large amounts of short-term US Treasury bills and other high-quality fixed income/cash holdings. The company is an investment portfolio of publicly traded and private equity holdings that utilize excess earnings for operational needs to buy new investments. It does not currently pay cash dividends, as shareholders benefit from the increase in value of their holdings. Recently, they have become a relatively small buyer of their own stock. Unlike many corporate CEOs and Portfolio Managers, Warren Buffett and Charlie Munger’s time horizon is that of their shareholders’ heirs. Thus, any large- scale disposal of assets comes as a surprise.

The publication of their report to the SEC of their publicly traded securities transactions in the second quarter was a surprise. In summary, they materially reduced their holdings in most bank stocks, although the report did not provide an explanation as to why. Earlier in the year they did provide an explanation as to why they sold out of all their airline stocks. They felt that it would be a period of years, not months, before air travel returned to 2019 levels. Without an explanation from “The Sage”, I am searching for one and have come up with two possibilities:

• The results for the first quarter were depressing and that got to him. (I use the singular, as the size and long-term holding period suggests that this was the curve ball pitcher himself making the primary decision.) Many felt that way, including a very long trail of the AAII weekly sample survey.
• While the political inclination of Mr. Buffett tends to lean toward the Democrats, he may have been worried about Berkshire’s huge position in the financial services sector. The thought that a specific senator from Massachusetts might be Treasury Secretary could well be scary. 

I have great respect for Warren Buffett and even more for Charlie Munger and have learned a lot from them. They have also enriched our clients and personal accounts. The only thing I promise to our accounts is that I will be wrong from time to time. Hopefully, I won’t take too long to recognize my mistake and correct it.  Nevertheless, I am not reducing our exposure to the financial sector at the moment, as with rare exception their stock prices do not reflect their earnings power in normal times. (A lesson I learned from the great John Neff.) I will admit that branches will have to be converted or closed. Quite possibly, lenders will be required to have equity in their borrowers, or similar socially driven radical changes. Governments and societies are unlikely to function successfully without a viable financial sector.

Question of the Week: What are your thoughts?

    

   

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

https://mikelipper.blogspot.com/2020/08/rotating-leadership-likely-on-horizon.html

https://mikelipper.blogspot.com/2020/08/more-to-learn-by-seeing-more-weekly.html

https://mikelipper.blogspot.com/2020/07/mike-lippers-monday-morning-musings.html

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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

STEALTH BOTTOM? and Other Considerations - Weekly Blog # 621

Mike Lipper’s Monday Morning Musings

STEALTH BOTTOM? and Other Considerations

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

         

Sector Selections?
Better Yields 
Market Structure Changes Implications?
Early 2021 Patterns
         

DID WE HAVE A STEALTH BOTTOM ON WEDNESDAY 3/18?
Is it possible the pundits did not recognize that we achieved the low for this “correction” cycle? Somewhat usual, I am asking the question that others don’t. First, to me “correction” is a term that should be applied to a down market attempting to correct a former structural weak up market. The US stock market likely would have gone down regardless of the surprise of the novel Coronavirus. Briefly, the causes were:

• China changing from being export led to domestic demand focused.
• The US market over valuing earnings per share, rather than focusing on operating earnings or GAAP net income.
• Excessive commercial and individual lending that was outside of the established banking and credit institution channels.

It was only a matter of time before a market that assumed its long expansion would continue unabated. The virus and its policy reactions showed collectively that the emperors of the world were all lacking the advertised “new clothes”

Two weeks ago, I prematurely thought that the market’s search for a bottom had been reached, although I warned it would be tested and the test could come at lower or higher prices. On Wednesday March 18th we had a substantial jump in NYSE volume. The VIX  index  jumped to 84, compared to 12 the year before. The daily low wiped out all gains achieved since the day the current administration was elected.

For the 3/18 low to be recognized as the low for this phase, it is likely that at least one more attempt to set a new low will occur and it didn’t happen on Thursday or Friday. Both the volume and VIX retreated. News chatter has also improved from both China and the District of Columbia.

At this point in time I am of the working view that we have probably reached a bottom, addressing the excessive elements mentioned. What the bottom does not contemplate is the structural changes to investment policies going forward. At least they are not currently clear to me. Consequently, I am beginning a very wide scan of the future, looking to the 2021-2025 period. The rest of this blog will hopefully generate responses from our very perceptive subscribers, with their contributions either for or against attribution.

SECTOR SELECTIONS
I have maintained that looking through the lens of more than 200 different fund categories, both registered with the SEC and other domiciles, I can see the daily work of some of the brightest investment people in the world. As many of them do not publish their views on a timely basis, I let the performance of their portfolios speak for them, supplemented by periodic publication of their portfolios and occasional conversations with a limited number of them. As a contrarian, the first place to look are the fund classifications that are doing poorly. Are they providing essential products and services, but are priced or delivered incorrectly?

The first two fund categories are globally priced but delivered locally. They are doing particularly poorly now, both in terms of fund performance and in their markets globally. The first is real estate, where all of their international, global and domestic fund categories are performing near or at the bottom. Their buildings do not seem appropriate for the increasing number of people that have or will have limited mobility. Furthermore, their pricing may have to change from being an estate asset, to being used for life or health use instead.

The second major global fund classification suffering are the energy producers and deliverers. In the future we will need more, not less energy as a key replacement for human labor and comfort in a climate challenged world. While consumers of energy will eventually pay for the whole chain of services through direct charges and taxes, they leave others to finance the system and thus have little optionality.

With the expected changes in both the automobile and real estate sectors, they should gain more influence and share the risks of what is delivered. That means they should become equity owners as well as consumers. Some movement in this direction will let the marketplace become more efficient in terms of pricing, including an investment in long-term delivery. This will become obvious when more people recognize that in our lifetimes, we are renters of assets, both short and long-term, and our control ownership dies with us.

For those who want to participate in future development, nothing is better than air. I am not focusing on the hot air produced by politicians and other sales types, or passenger travel. The current requirement to work from home emphasizes the importance of communication and package delivery. The physical and financial limitations of pipes and wires are likely to reduce their importance in the new world. Telecommunications will become our way to make our work, safety, and entertainment more efficient. The management of telecommunications has been tied in the past to the financing and rate setting of the public utility model. Ultimately, consumers pay for telecommunication services through a number of different prices and taxes. To the point consumers do not recognize the all-in cost of what they are getting, that should change. (This may lead to smaller governments at all levels.)

The second and largely unexplored investment opportunity of the future is drone package delivery by air. We are already using drones for both package delivery and crowd identification/control, particularly since the virus crisis. (Loudspeaker equipped drones are being used in an attempt to disperse crowds and direct them. They are also being used to patrol various locations.) We need to establish a grid system for drones that allows them to travel safely and efficiently, as well as instituting other regulations. One should expect weightier deliveries with appropriate policing. I wonder when drones will  carry robots to finish the delivery, or perhaps do some of the on-sight work. There should ways for us equity types to participate in this innovation.

The advocates at Matthews Asia have put forth an interesting view. Can China, now that it no longer has any new cases of the Coronavirus being reported from Wuhan, a city of 11 million, be a good place to invest for a globally diversified portfolio? There is evidence as to the power of a command economy. Large companies are loaning money to their smaller suppliers. Apple has all its Chinese retail stores open, distinct from their stores in the rest of the world. An interesting headline from the Financial Times shows that Apple is not alone, “Volvo’s China plants almost back to pre-shutdown levels.”

BETTER YIELDS
Over the last couple of years, few if any individuals or institutions could pay their increasing bills from the interest or dividends available in the US market. This may be changing. We may be returning to an old model where equity dividends were larger than those of high-grade bonds.

Each week Barron’s produces a Best Grade Bond yields index and this week the index read 4.01%. (That is the highest I remember in a number of years.) In the same issue there was an article that highlighted the following yields from large financial institutions: J.P. Morgan Chase 4.2%, Morgan Stanley 4.5%, M&T 4.2%, and US Bank 5.1%. I believe all of these are owned by Berkshire Hathaway, which I also own along with J.P. Morgan and Morgan Stanley. More importantly, these yields are below the Barron’s index of intermediate grade bonds (5.37%), which have a higher yield due to their perception of having less safety. In that article they also show the banks, with what they calculate as their stressed price/earnings ratios: J.P. Morgan at 22.2x, down to 10.1% and Morgan Stanley with an earnings power calculation assuming large credit defaults. I do not suggest these companies for your investment, but to show that there are corporate yields higher than high grade bonds.

If any of our subscribers own or are contemplating municipal bonds, I would be happy to discuss the risks that have led to their sharp price declines.

MARKET STRUCTURE IMPLICATIONS
A perpetual warning that should be given to all investors in publicly traded stocks and bonds, is that companies and holders share the same name, but not necessarily the same path of progress and value. The day-to-day price of securities is a function of its owners, particularly those who are selling. The sellers are transacting to meet their own needs and desire for liquidity, as well as to partake in other opportunities that may or may not be competitive with the stock’s name. In the past, most cities and towns had street level walk in brokerage offices and registered representatives to handle customer originated ideas. Their somewhat safer house recommendations have been replaced by packaged products like pensions, 401-k or similar products, and mutual funds.

The upstairs broker or website producer is now a registered investment adviser, or perhaps should be. They wish to have the customers either legally or actually become a discretionary account. Some of these advisors are really quite talented, but others are not. Many of these accounts perceive that they invest as major institutions do, but do not really understand the needs of the institutions. One way or another, they and others have been heavily invested in the Dow Jones Industrial Average (DJIA). Interesting because the DJIA was the worst performer of the three popular US stock indices on the way up to the peak, as well as the worst of the three on the way down. This is interesting because the junior in terms of age and repute, the NASDAQ Composite, was the best in both directions. The NASDAQ voluntary market makers provide the least liquidity of the three markets. In the latest week, 88% of the stocks listed on the NYSE fell, while only 74% of those on NASDAQ declined. More aggressive institutions and individuals are prominent investors in the outgrowth of the OTC market. This suggests that the herd instinct of the public and their less than market sophisticated advisers were panicking last week, which is one of the characteristics of a turnaround.

EARLY PLANS FOR 2021-2025
I have for sometime taken the view that the sales and earnings reported for the current year have little value in making investment judgments for 2021-2025, the shortest period I normally focus on. As this blog is already quite long, I will outline briefly the initial part of my thinking in building an investment plan for the future. For this purpose, I will just focus on the political input.

I believe in a fan approach to the unknown of taking two extreme positions. In this case I assume one party takes total control of the White House and both houses of Congress and list their priorities. Next take the other side. If you have more difficulty with the second, you haven’t been paying attention and are letting your political leanings influence your analysis at a cost to the performance of your investments. Beneath the surface, both parties are now badly fragmented and being held together for the sake of the election, primarily in the House and somewhat less in the Senate. The day after the 2020 election is over the campaign for 2024 begins in earnest, with a high probability that there will be two different candidates for president. As a practical matter, whomever wins the various elections will probably need to give ground to the “special interests”, often represented by their former colleagues. Furthermore, the challenges that will dictate the record of the office holders will be surprises like Covid-19 and changes in governments and other powers around the world.

I will pay attention to the political competition which is a “parlor game” for the media, but I am more interested in the likely changes in supply and demand for products and services. I would appreciate any thoughts from subscribers, as far too few people are thinking about the future constructively. 



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/03/searching-for-bottom-understanding-and.html

https://mikelipper.blogspot.com/2020/03/searching-for-bottom-and-plan-weekly.html

https://mikelipper.blogspot.com/2020/03/should-changes-in-markets-change-your.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

Short-Term Recognitions Plus Longer-Term Work - Weekly Blog # 590

Mike Lipper’s Monday Morning Musings

Short-Term Recognitions Plus Longer-Term Work

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

Short-Term Recognitions
We have reports of financial cycles since the beginning of recorded history and are always in some phase of a cycle. The keys to financial survival and future success are to recognize where we are in the present cycle, something which is almost always difficult to do emotionally. It is tough to label the current down draft. Is it a trading incident, a correction (normally about 10% from peak), the beginnings of a “bear market” (normally about 20% from peak), or a major crises that occurs once in a generation, with a decline of 50% or more? Only time will tell which of the alternatives describe our immediate future.

In the current US stock market most of the trading volume is from groups that are short-term oriented. With this orientation they tend to react to changes in sentiment rather than long-term trends. In the current market environment, I tend to focus on price changes for the NASDAQ Composite Index, which has risen the most of the three main stock market indices. The Composite includes a fair number of tech stocks and companies that provide services. Both of these have been growing their revenues faster than the industrial companies in the Dow Jones Industrial Average (DJIA) and the more broadly invested Standard & Poor’s 500 Index. (If it weren’t for the weak performance of the mid/small mixed financial services companies in the NASDAQ Composite, the lead would be even larger.)

Viewed in this light, the most recent weekly difference in the number of stock prices rising or falling may be instructive. The New York Stock Exchange (NYSE) had 373 gainers and 440 losers, whereas the NASDAQ had 203 gainers and 516 decliners. The NASDAQ is only off -5.21% from its peak, half-way toward being labeled a correction. Clearly one goes through each gradation until the ultimate bottom is reached. Whatever the appropriate level, some further fall is a reasonable expectation.

As I and others have stressed, the current market is led much more by sentiment than the investment fundamentals found in financial statements. Nevertheless, one should recognize that sentiment can impact prices for securities, currencies, and commodities. Each week The Wall Street Journal (WSJ) shows the weekly price movement of 72 items. Like many sentiment indicators, the rises and falls are normally bound in a 60/40 range. This week only 30% of the prices rose, with 70% declining. If attitudes toward prices remain outside of their normal range, it could be significant and could point to a larger decline than a mere correction.

One statistical series that may be misinterpreted is the constant sale of stocks by well-known value investors. These trimmings are being viewed as disenchantment with the holdings and while some disenchantment may be true, before reaching that conclusion it is necessary to review their record of inflows and outflows. When these previously successful investors are forced to make a partial liquidation they often choose among their most liquid positions, not necessarily their weakest. This has been the pattern for many quarters. If the downturn becomes more pronounced the time for trimming will likely end and favor totally selling out of selected names that may not have the same chance of price recovery. This typically happens near the end of market declines.

Time to Build Research Lists
In past market declines my fellow analyst friends would have lists of names and prices they wish to recommend to clients and/or purchase for themselves. All too often these lists are not executed due to the low-level of confidence in the new analytical work being done. It is with these thoughts in mind that I am now suggesting that this is the time to begin in-depth work on new names, not in portfolios or coverage patterns.

The first place I would look for candidates is the mutual fund investment objective averages. There are 19 fund averages that have risen less than 6% this year and 4 that have produced negative returns. These are:

Agricultural Commodities     -8.88%
India                        -5.58%
Natural Resources            -5.26%
Base Metals Commodities      -2.80%

Apart from the funds focused on India, the other three are classic supply/demand vehicles which are now suffering from insufficient demand for the current supply. We know from history that these conditions lead to future supply being curtailed by the withdrawal of some of the participants, although with both population and wealth growth there is little question that future demand will be higher than today’s level in the future.

India is a fascinating opportunity currently experiencing internal political issues. Nevertheless, it is the fastest growing major economy in the world. Faster than China and within twenty years it will have a bigger population too. Fourteen of the remaining investment objectives focus on international investing, many with an Asian mandate, highlighting two possible attractions. The first is summed up in a quote from the Chief investment Officer of Matthews Asia. “Growth that depends less on trade and more on continued savings, efficient investment, and institutional reform. All things to which Asia remains committed.” For a global investor, the largest risks is a decline in the value of the US dollar relative to other major currencies. (This may also reflect a relative decline in the standard of living for many US residents.)

The only domestic oriented investment objective with a low year-to-date average return of +4.25% is Small Company Value Funds. As with other value-oriented investment objectives, performance has lagged most other groups for the past several years. These funds must meet redemptions by liquidating and dealers might not be willing to take their discard into their limited inventory. The three commodity types mentioned above will rise when their markets are dealing with shortages.

There is another category that at some point may include some real bargains, internally driven turnarounds. Internally driven turnarounds most often result from new leadership and the restocking of operating management with new talent. Introducing new products and services with attractive pricing will also help. Unlike the swing from oversupply to shortage, internally driven turnarounds take time and may attract short sellers who are not patient.

Investment Conclusions

1. Review your portfolio for those positions you want to own for the next bull market and dispose of the rest.
2. Start the lonely job of researching new potential holdings which are likely to be winners in the next new market phases.

Questions of the Week:

1. Are you prepared for a down market?
2. Are you looking for the next Bull Market Winners?  

Did you miss my past few blogs? Click one of the links below to read.

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

https://mikelipper.blogspot.com/2019/07/chinese-emperors-learn-all-roads-lead.html



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 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

Signs of Enthusiasm, China Concerns, Centurions are Coming

Introduction

Because I like to think about different timespans as an improved way of managing money, I look at different stimuli in terms of impacts on those timespans. The focus of most commentators is on the short-term, which can be described as until the next performance reports all the way out to the rest of the market cycle. Some focus on intermediate periods that follow after the current cycle. And very few will focus on the long-term needs in terms of their responsibilities. Nevertheless, it may be useful to arrange some of the stimuli that bombard us each day.

Short-Term

On the very day of the publication of the statement of President Trump  “Pittsburg Not Paris,” the three major US stock indices went to new highs. The enthusiasm for stocks is global with five markets showing 2017 gains of over 20% through Friday: NASDAQ +27.06%, Bovespa +25.57%, Hang Seng +24.87%, IBEX 35 +22.31%, and FTSE 100 +21.9%. While a number of the gainers are being driven by advances in Emerging Markets, it is not as usual supported by or led by commodity prices.

Based on past history, two cautionary notes should be observed. The first is a reported statement from an old friend and "bubble watcher" Jeremy Grantham: "The US market has entered an era of permanently higher valuations." (A look at history questions whether any valuations can be permanent. This is Bull Market talk.) The second was noted in Barron's based on the work of Bespoke which commented that April margin balances were the fourth consecutive month of record levels. Bespoke observed that the last two bear markets have occurred after margin balances have peaked.

At the moment I view all of these inputs as cautionary signs. In the past, important peaks have been the result of greater amounts of enthusiasm with higher performance numbers, new "geniuses" and considerable leverage. I am not predicting this, but at prior peaks I have seen a number of mutual funds that reported gains of +100% or more. At this time we do not see people changing their lifestyles and marriages based on their new theoretical wealth.

China May Dominate Intermediate Periods

The generally accepted view is that China will become the globe's number one economy within the foreseeable future. My own opinion is to always be cautious about generally accepted views, they have proven to be wrong too often in the past. In addition, the Chinese economy and society are highly leveraged operationally and financially and things can go wrong. At the moment, I feel confident that China will become the most important variable in determining future investment policies around the world. With those thoughts in mind I will summarize two important inputs. The first is from our friend Byron Wien's reaction to his recent trip to Asia (including China) speaking with institutional investors. The second are the views expressed by the portfolio managers and investment strategist with which I visited recently.

Byron Wien's China Briefs

• Capital formation is growing 4% with inflation at 3%.
• Leverage is the major problem with total social and financial borrowing  250% of GDP.
• Interest payments are 14% of GDP.
• Shadow banking interest rates are 14%.
• Regulators will permit banks to convert non-performing loans into equity.
• Return on equity for private companies has dropped from 18% to 9%.
• Equity market valuations are high at 20x with meager growth.
• Middle class expected to reach 60% by 2020 from 43% in 2015.
• Population is rapidly aging and expected to reach 370 million in 2050 vs. 170 million in 2015.
• Healthcare expenditures are 5.5% of GDP.
• Life Insurance covers 2% vs. 10% in developed markets.
• The solution to excess industrial capacity and jobs is "One Belt One Road."

Matthews Asia's Mindset

In response to the expected downgrade of China's credit rating, Moody’s* points out that the bulk of the excessive leverage exposure is in the largely State Owned Enterprises (SOE). I believe most of these loans are held domestically by government owned or controlled banks. The key social issue is jobs. Luckily the majority of employees work for private companies that are profitable. Actually the private companies are growing their earnings, but the periodic waves of speculation have been reacting to both global and internal political trends depressing their prices. (This is just the opposite of India, the best performing large market this year, where earnings have not met expectations. The enthusiasm for the current political and monetary conditions has driven the stock market higher.)

*Held in the private financial services fund I manage

Matthews Asia sees future opportunities in both Micro caps and some of the under-followed "A" shares. In its portfolios that invest in China, Matthews Asia is investing in both the creation and the use of technology applied to health care and related aging needs. With China being such a big part of Asia's future, one would assume that in the long-run Matthews Asia believes that China will be a positive for Asian investing.

My long-term concern about China is that the global history of railroad and port building with too much leverage can create unexpected volatility.

"Beware of the Centurions" in the Long-Term

If my memory of military history is correct, in the conquering armies of Rome the key maneuvering units were comprised of one hundred men commanded by a Centurion. It was the Centurion that transformed a diverse group of undisciplined men into a well trained disciplined military unit. We are entering an era when an increasing number of people will be at least 100 years young, and we and they are unprepared for this transition. A thoughtful piece by John Mauldin alerts us to the demographic fact that increasingly we will be dealing with people that pass the century mark. As individuals and as a society we are not prepared for this change. For example when Social Security was initiated in this country it was based on the belief that men would retire at 65 and die at 67. This was conservative in that people born in 1930 had a life expectancy of 56 for men and 62 for women. Compare that with life expectancy for those born in 2007 to be 103 and 104 respectively, in the US. This is a global phenomena with six other developed countries’ expectancies in the same range. Japan is the leader with 107 years.

One of the unspoken conceits of investors is that they are not the average person. To the extent that they can prove that by being wealthier, the top 20% on average in terms of wealth, are expected to live five years beyond the average. The poorest are expected to die two years earlier than the average. I can understand the distinction because of diet, less risky manual labor, and quality of health care. I don't know what assumptions are built into these projections as to the developments in medicine, agriculture, working conditions, and psychological health. Further my basic training at the Racetrack and the US Marine Corps questions trusting averages but has a distaste for being in the middle of any group.

Regardless of the projections, as societies we are not doing a very good job of caring for the present seniors. Fundamentally the reason for this is we have insufficient dedicated capital. This is a global problem impacting all the developed world and many of the developing countries. Almost every government-sponsored pension plan is underfunded to meet the present retirees, let alone prepared for the Centurions.

Strange as it may seem, I see this is an opportunity for investment gatherers and managers. As Centurions grow in number, increasingly they will exercise their votes at both the local and national levels. I expect at some point we will evolve into a two level tax system where there will be charged a higher level for consumption spending, perhaps some type of VAT, and a lower bracket for retirement spending. Whether any unused capital can be passed on without a tax, I don't know. Further our laws and practises will react to some concept of age discrimination in favor of utilizing the best people for the job in one form or another. Unless we do something, the Centurions will weigh heavily on our productive capacity.

Critical Investment Question: Rank which is most important to you and your investments: (a) short-term market outlook, (b) impact of China, or (c) providing increased retirement capital. Please share your thoughts with me.

__________

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Almost Everyone Is Really Bullish

Introduction

After listening to amateur and professional investors for a lifetime, I have concluded that I should largely disregard what most people say and write. What matters is what they actually do. 

At the moment, market volumes are low, people are not selling their tangible investments (including their homes and the artwork in their homes or in secure free port locations) en masse.  We are not seeing smart, investor-focused companies liquidating. In other words “TINA” (There Is No Alternative) has been replaced by “FOMO” (Fear Of Missing Out). These are two arguments as to whether or not prices will be higher. There is some stroking of one’s intellectual chin as to when and how big a valley we must ride through to get our rewards.

Two Arguments

The favored ways of reaching these conclusions are (1) reliance on our faith that the cyclical secular bull market that has existed in the US and elsewhere for two generations will continue; or (2) like my fellow numbers oriented addicts, they can pour over the current and future dispatches from the global investment fronts. As is often the case, faith wins out in terms of our emotional and psychological stability. As a continuing student of history, particularly of unfulfilled predictions, I can not say this is a wrong approach. However, in this era of microsecond overload of so-called facts and figures, I can not escape my predilection for gathering and sorting almost every morsel in the hope of finding at least temporary clarity. The rest of this blog post is designed to help my fellow missionaries as they look deeply for investment truth or at least a higher level of certainty.

The US Stock Market

We have now gone through what seems like a lifetime of not achieving a new high. It has only been one year. I remind readers that it took the Dow Jones Industrial Average sixteen years from the first time it hit 1000 until it finally surpassed that number in a meaningful way. Market analysts characterize a long flat period as either one of accumulation or distribution. If there is a sustained price rise going through the old high it is labeled accumulation. Likewise if the range-bound price level is broken on the downside it is labeled as a distribution. 

In an oversimplification, market analysts attempt to characterize the flow of money from strong players to weaker ones. History suggests the weaker ones are largely driven by emotions (as the disappearing individual investors) and the strong players are felt to be the professionals.

The Financial Services Sector

As many know I follow financial services companies intently. Most publicly traded brokerage firms with large retail business are not reporting commission income gains. This is seconded by many mutual fund management companies whose individual equity businesses are not growing. Many institutional investors continue to experience positive net flows from contributions and other sources. However, this is not just a two-sided battle between long-term institutional investors and retail public investors. In addition there is the trading community including hedge funds. As they can be long and short, they tend to magnify the intra-day volatility because of their leverage through margin and the use of derivatives.

My View

As with most who are gathered under the FOMO banner I believe that we will see meaningful new highs. Notice I did not put a time tag on the prediction or indicate how low the market may go before reaching a new high.

Index Funds, Revisited

Some foolish investors believe the way to play this dichotomy is through Index funds. The reason that it is foolish is not that it won’t participate in the move. It is exactly that it will participate, but not optimally.

According to one public survey some 71% of retail Index fund investors believe they are taking less risk than in actively managed funds. They are confusing the somewhat muted daily volatility of a broad based index with a concentrated fund portfolio. I believe this advantage is lost, as over time market emphasis shifts and leadership changes. Further, Index funds do not carry cash and rely solely on “approved participants” to bring in or take out securities.  (In our managed mutual fund portfolios we use both passive Index or like Index funds as well as concentrated funds.)

The Real World

We normally think of snow in terms of the winter. Gamblers often refer to a stream of bad luck as snow.  After recovering late in the first quarter, the global economy hit snow in April. The first confirmation to me was a luxury company that announced April sales were 15% behind a year ago. When the wealthy cut back they are sensing something. Globally, almost every company that we follow experienced what I hope is only a hesitation. This is an April phenomenon as, according to ThomsonReuters, 73% of the 493 reporting companies in the S&P 500 beat earnings estimates. (Normally the beat ratio is 63%.) What is more worrisome to me is that only 52% beat the ratio in terms of revenue estimates, suggesting some financial engineering is at work.

Are Yields Heading Back Up?

The fixed income marketplace is broad and deep and it is a bit unfair to use only two yields to identify a trend that could be something of the canary in the mine as a warning to equity investors. According to Barron’s the average yield on a group of intermediate quality corporates last week rose to 4.93% from 4.58% the week before, but still a little lower than the 5.09% a year ago. Minor changes in yields for the highest quality corporates perhaps should calm us. Money Market Deposit Accounts also bounced up.  In this case from 0.22% to 0.25%. This may indicate some tightening of the available money for consumer lending.

Two Former Morgan Stanley Thinkers Worth Reading

1.  Byron Wien, now with Blackstone, for years was reporting on his conversations with an unnamed influence he dubbed the “Smartest Man in Europe.” Unfortunately, the investor, Edgar de Picciotto, Chairman of Union Bancaire Privée in Geneva, recently died.

Wien recounted Picciotto’s numerous investment successes and his philosophies. He clearly was early onto numerous investors that did very well. I believe he had very concentrated investments. He foresaw opportunities that were considerably less risky than they appeared to others who came in later. He used his mistakes to improve his thinking. Contact Byron for a copy of his latest blog.

2.  Steve Roach for Project Syndicate has once again highlighted the US dependence on China. (He headed Morgan Stanley’s Asian business after a career as its global economist.) His view is that the US is growing by absorbing savings from China. He is concerned that this source of support for the US will not continue. Roach believes that the US needs to be generating sufficient savings to invest in its own growth.

Other Asian Views

Matthews Asia, a Pacific oriented fund group is re-positioning one of its funds. The Asian Science & Technology Fund is broadening out to become the Asian Innovators Fund. Matthews Asia sees this new focus as a much bigger mandate, as not all innovation is produced by technology. Many commercial and financial activities are benefiting from non-tech innovation. (We have been shareholders of the prior fund.)

Much of the flows into and out of Exchange Traded Funds (ETFs) is caused by shorter term traders. For example in the first four months of 2015, $65.4 Billion went into Global/International funds. In the first four months of this year net redemptions were $5.9 Billion.  In only one of the four months was there was a net inflow of $4.2 Billion. Not surprising in the first two months of the year $10 Billion exited. This kind of volatility was magnified by the thinness of most overseas markets and particularly some of the Asian markets. Investors can use this to their advantage if they counter-time their moves to the regional headlines.

Patience will be required as both “TINA” and “FOMO” are functioning, but one needs to be prepared for temporary reverses.

Monday is a Memorial Day holiday in the US, where we recognize all those who have served their country in times of war and other troubles.

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