Strategically, Time to Think Differently - Weekly Blog # 927

 

 

 

Mike Lipper’s Monday Morning Musings

 

Strategically, Time to Think Differently

 

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

  

 

Warning: Almost No One Will Agree, Nevertheless Consider

My Burden: Hedging

 

After a market week of lots of good earnings and media pundit optimism, it’s time to worry. Individually, before we consider securities investments, we should consider our personal long-term investments. For most of our adult lives our two biggest investments are our homes and jobs. While we believe we know the numbers, we are wrong!

 

We fail to include in the analysis of our residence the true costs that come with the property over time. For instance, we do not include real estate taxes, either paid directly or included in rent payments. If we stay in our homes for ten years, in one place or more, the aggregate cost will probably equal the cost of buying initially. But that is not the actual cost of living in a home. That amount should also include the cost of local organizations we join, as well as the cost of any repairs and maintenance. Thus, the combined cost should be considered, as well as the planned next location, which likely represents a potentially large unhedged risk.

 

As large as the cost of home ownership is, it is hopefully smaller than the next risk. For most of us, our biggest risk throughout perhaps the first twenty years of our adult lives, is employment risk. If we work for one or multiple employers and we are not self-employed during most of our working years, our biggest risk is employment risk. We are living in a fast-changing economic world, where employers disappear as a result of business mistakes, technological change, badly executed mergers, and younger, smarter, better educated, and cheaper competitors.

 

We are Not Helpless

Over time, we can not only help ourselves but also accumulate sufficient capital to provide long-lasting wealth to cover our own lives and hopefully those of our loved ones too. This can be accomplished by regularly spending less than we make through our jobs and investments. Cyclicality is our enemy. As we move up in the commercial world an increasing portion of our wealth comes from accepting portions of compensation that have equity-like rewards and risks. The further you move up the economic ladder, the greater the rewards and risks. Additionally, the higher you go up the ladder, the more cyclical it becomes. Income fluctuates with sales and profits, but also due to changes in politics within the organization. This cyclicality should be hedged to the degree possible.

 

Selection of Investments is Critical

Picking good investments is always difficult. For the most protection, the primary goal should be seeking assets that hedge those investments generating the highest gain. I believe we are on the cusp of a period of major change, not the continuation of “happy talk” optimism. This past week there were dramatic headline changes of direction, but the market as measured by the S&P 500 barely returned to its prior high. Concurrently, the Economic Cyclical Research Institute (ECRI) industrial price indicator dropped to 122.27% from the prior week’s 131.20%. While this was an extremely happy reading of growing inflation, I suspect it was driven by natural gas prices plummeting -21.41% and diesel falling -4.79%. Far too many retail investors follow prices on the NYSE, where 39% of the stocks declined for the week. However, the better performing NASDAQ Composite saw 56% of its prices fall. Also, the American Association of Individual Investors (AAII) weekly sample survey showed the bullish outlook falling to +39.7% from +44.4% the prior week. In the real-world January produced the largest cut in jobs, which have been falling for 8 months.  

 

Conclusion: One Should Hedge

 

 

 

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Mike Lipper's Blog: Is This The Week That Ends Instability? - Weekly Blog # 924

Mike Lipper's Blog: How Much Longer Can We Avoid Thinking About the Long-Term? - Weekly Blog # 923

 

 

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Preparing - Weekly Blog # 809

 

Mike Lipper’s Monday Morning Musings

 

Preparing

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

 

 

 

Little did we know that nursery tales were preparing us to be sound investors. Remember the story of the three little pigs who all built homes, but only one survived the storms because he took the time to build with bricks.

 

Later, we grew up and found ourselves in a marching unit alert for the preparatory command, immediately prior to an execution order. We should always have been searching for preparatory signals to avoid major losses and unexpected gains.

 

Last week we warned that sudden rallies are usual in “bear markets”. Only time will tell if we have entered a bear market and if we should identify the following as preparatory signals. (What is your opinion?)

• Perhaps the soundest bank in Asia, DBS, was instructed by Singapore banking authorities to suspend various expansion efforts for 6 months.
• The leading banker in the US announced that he intended to sell roughly 12% of his ownership in the bank for estate and other reasons a year from now.
• In a private discussion, a CEO of a very successful private company bemoaned many companies for not being close enough to their customers to help guide them through the coming problems.
• Both Goldman Sachs and Morgan Stanley have reduced employment of talented people a couple times. A major large private investment organization has done the same.
• I went to an upscale department store looking for an appropriate business casual shirt in my size. The store only had small, medium, and large shirts, not the usual array of arm lengths or shirts with 2-inch variations. This brought home the statement by UPS that their package business from Hong Kong was down because retailers were reducing inventories.
• Panera just announced that is laying off 17% of their workers before they do an IPO. There has been an increase in mergers, but most of them are stock for stock deals. This is a sign that cash is too expensive, and their own stocks are no longer cheap.

 

Preparing Oneself

Marcus Ashworth is a brilliant columnist, which means that I agree with him. He wrote “Probably the most underrated skill in finance is knowing when to sell”. It may be wise to first identify what to sell. I suggest the first step is to identify each holding in terms of purpose, as either speculation or investment. The main difference between the two is whether your bet is based mainly on the belief that the price will rise. Or alternatively that earnings will grow, new products/strategies will be launched, new leadership will be in place, or there will be a closing or a collapse of principal competitor.

 

The next step is to find or create an appropriate peer group. (This is easier for mutual funds.) Then, in the shortest reasonable time-period, arrange the peer group into quintiles. (Caution, avoid dividing the peer group into quarters or halves.) If the peer group you are studying is a narrow-based specialty, your best bet is to be in the top or bottom quintile. If it is in the bottom quintile you are betting on the changing character of your investment making it a winner. These types of securities normally do best for brief periods.

 

I follow a different approach for diversified equity holdings. My approach is less volatile than the general market and spends most of the time in the second or third quintile. It is rarely in either of the extreme performance quintiles. These placements are appropriate for long-term holdings with periodic payments to beneficiaries and has the benefit of keeping clients happy and maintaining relationships.

 

When to Sell

The biggest risk for many long-term investors is impatience, which was noted by Blaise Pascal in the 1600s. He said, “All of humanity’s problems stem from man’s inability to sit quietly in a room alone.” This sitting approach works better with large portfolios of high-quality stocks, because over time the gains will be greater than the losses, particularly during inflationary periods.

 

We are quite possibly not in such a period. Charlie Munger recently commented that during Berkshire Hathaway’s (*) first four decades of Warren Buffet’s ownership history it was relatively easy to pick sound investments. In looking at the company’s 3^rd quarter report there were a considerable number of subsidiaries whose earnings were disappointing, but the success of their larger positions more than made up for those that declined. (They have built up a very sizeable cash reserve in anticipation of finding good future homes for their acquisitions.)

* Owned in managed or personal accounts

 

Outlook(s)

The longer-term outlook is quite attractive, with IBES estimating S&P 500 earnings per share reaching $276.02 in 2025 compared to $218.09 in 2022. The current concern about corralling the rate of inflation does not seem to be an issue with 30-year US Treasury paper yielding 4.75%, not much different from the 10-year rate of 4.56% and the 2-year rate of 4.83%. (I suspect that there is considerable amount of leveraged buying of 2-year compared to the 30-year, which is one of the reasons shorter rates are higher.)

 

However, the reason for discussing multiple outlooks is the shorter-term future looks more troubled than the longer. If one treats the period since the beginning of COVID-19 as a single unit, we have been going through stagflation with volatility. One of the reasons the stock market has done as well as it has is due to an increase in leverage, both operational and financial. Revenues have been going up marginally, but reported and adjusted earnings have risen by a multiple of sales. This resulted from an increase in private debt and other forms of debt extensions driven primarily by large caps. (In the latest week, declines represented 1% of the companies traded on the NYSE vs 23% on the NASDAQ). I previously alluded to the number of middle size companies owned by Berkshire not doing as well as in the past.

 

There were contradictory indicators delivered this week. On Saturday the WSJ reported that 90% of the weekly prices of securities indices, commodities, currencies, etc., were up. The sample survey of the American Association of Individual Investors (AAII) had 50.3% bearish over the next 6 months vs. 24.3% that were bullish. The bearish reading is not only twice the bullish, but entered an extreme reading and was much larger than it has been over the last couple of weeks. (It is possible that the sample skewed differently this week or participants reacted to the news.)

 

My Operating Conclusions Remain the Same

 

Some trouble ahead, with better markets in 2025. 

 

 

 

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Mike Lipper's Blog: Indicators as Future Guides - Weekly Blog # 808

Mike Lipper's Blog: Changing Steps - Weekly Blog # 807

Mike Lipper's Blog: Change Expected - Weekly Blog # 806

 

 

 

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Change Expected - Weekly Blog # 806

 

Mike Lipper’s Monday Morning Musings

Change Expected

 

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

 

 

 

Unusual Items

• !200 CEOs give up their positions.
• Disappointing sales for LVMH among most of their 75 labels. High-end retail sales below expected results in almost all geographies, the most damaging being China and the US.
• Average ACT scores in the US are the lowest in 30 years, with Math scores of 19.5 out of a possible 36.
• Expect liquidity pool to shrink as consumers use up government cash. Will likely lead to market volatility.
• NASDAQ declines for the week, with 61% of prices down versus 50% for the NYSE. The NASDAQ has been the performance leader for some time.
• China is producing 49% of global shipbuilding and has 68% of ship orders. Some are high value and some high tech.

 

Most Logical Changes Expected

For some time, the mutual fund performance rank order has not varied much. Using the latest week through Wednesday and 5-year performance. Ranked by 5-year performance:

                    ---Performance---

                    Latest

                     Week      5-Year

Large-Cap Growth    +2.75%    +11.67%

Multi-Cap Growth    +2.40%     +9.19%

Medium-Cap Growth   +1.52%     +7.30%

Small-Cap Growth    +0.15%     +5.11%

 

International       +2.28%     +3.57%

Global              +2.00%     +2.62%                                                                                                                                                                                            

Point of View

Believing that we live in an irregular, cyclical world, I expect the domestic rank order to be reversed in some future market period. One reason is the current effort of the FTC to reduce M&A activity of large companies acquiring smaller companies in horizontal deals, which I expect to fail. I anticipate an increase in M&A activity in the financial services sector, which includes banks, fund management companies, investment advisers, and fintech operations. Highly effective salespeople will be greatly valued, as will critical tech people. There will be cross-border and cross-industry mergers.

                  

 

 

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Mike Lipper's Blog: Stock Markets Move on Expectations - Weekly Blog # 805

Mike Lipper's Blog: Prepare to be Bullish, Long-Term - Weekly Blog # 804

Mike Lipper's Blog: Selling: Art & Risks, Current & Later - Weekly Blog # 803

 

 

 

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Tis the Season to be Mislead - Weekly Blog # 558

Mike Lipper’s Monday Morning Musings

Tis the Season to be Mislead

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

                                                                     

Standard Review and Outlook

I have written and read many reviews and outlooks over my career, both as an investor and a fiduciary manager. These documents are interesting and represent the most positive thinking of the writer, editor, supervisor, key sales people and compliance officials. Most spend a good amount of space describing the immediate past, with a slight alibi for under performance. For the most part the outlook is an extension of current conditions, likely to turn out to be benign. Those who know me would expect a contrary point of view. I hope not to disappoint. Even if I am wrong, some of these views will give depth to the more popularly expressed views.

Career Risks

This may well be the first outlook to start with this topic, but it hopefully will cause professional investment people and senior politicians to focus their actions on reducing the chances of repeating their 2018 performance, or worse. The best that than can be said about last year is that the results were reasonable considering the prior good times when waves of enthusiasm carried stock prices and political popularity to new highs. In some respect we have come back to earth. The only problem with the small net progress made in 2018 is that it reduced the longer-term growth rate, which is the underpinning of our current position and its remuneration.

Faced with the somewhat disappointing results of 2018 there is a natural drive to do something to improve results. In most cases this translates to committing more assets to short-term solutions, often by reducing reserves. While 60 of the 72 prices representing stock market indices, currencies, commodities, and ETFs rose last week, there may have been an excess investment of reserves, which is often a precondition of both bear markets and recessions. These asset allocation shifts don’t cause bear markets and recessions, they just make them more painful. Let’s place this microscope on three careers to raise some concerns.

Investment Professionals

Over time most professional investment people have delivered good performance relative to client’s actual constraints. In a period when most security prices rose in tandem with market indices or sector indices, passive vehicles looked to be more attractive than active choices. (This view was reinforced as commission brokers became fee charging investment advisors). Recently, instead of a steady increase in the number of new firms, hedge funds and mutual funds, the opposite has been happening. Organizations are merging to get control of assets that are no longer being won through sales efforts. In the merger, one of the back offices is eliminated and the best of the investment and sales people are retained. Even with this group of survivors, once their guaranteed employment period ends there will likely be a second round of layoffs. By the way, there is no evidence that the ultimate client is better off after these mergers. Seeing the prospect of this on the horizon, current employees may elect to push more aggressive strategies, even after a ten-year expansion.

Publicly-Traded Corporate Executives

Many corporate C suites are like the old fighter squadrons where there were bold or old pilots, but no bold old pilots. Often, the executives that rise to the top have more political skills than vision and help select boards of a similar nature. Most of the Fortune 500 CEOs are in their corner chair for five years, which is generally not long enough to go through a recession and a recovery. Thus, they tend to opt for capital preservation rather capital growth. This is not new, which is the reason why wise entrepreneurial companies with much less in assets outgrow their larger competitors. New technology’s disruptive forces wait for no one and some foreign companies may have what it takes to win business away from slower moving behemoths. Often, being a little bit bold is insufficient to hold off competitors. At some point boards, with or without activist sponsorship, demand a bold replacement or sale of the company.

Political Leadership

Both the “Big Two” (US and China) are trying to keep their expansions growing to protect their employment base. Further, in the US the opposition party is led by individuals older than the US President. Both leaders would prefer to focus on the longer term, but they are being forced to prolong and accelerate current growth. This is the trap that will increase the pain when the economic slump occurs, as happened in Ancient Rome, to Louis XIV and to Herbert Hoover/ Franklin Delano Roosevelt. Economic and military wars lead to deficits and tax increases, where opposite measures might cushion the decline and accelerate the speed of the recovery. But this kind or restraint would necessarily need to accept a slowdown, along with the political risk of a rise in unemployment, which would need to be managed.

If !!!

If corporate and political leaders are slow to support a decelerating economy, they might put off the inevitable recession by finding new and younger leadership.

Watch Emerging Market Bond Yields

Franklin Templeton (Franklin Resources*) 2019 outlook was entitled Distortion, divergence, and diversification. This thoughtful piece had three themes and was written by their head of equities, chief investment officer of Templeton Global Macro, and CIO of Multi-Asset Solutions:

• The state of the world which investors have become accustomed to will change, with low correlation and low probability of outcome.
• Local-currency emerging markets are showing the highest level of undervaluation.
• Opportunities exist globally, as disparities narrow between the US and other countries.

I was particularly interested in a chart of two-year bond yields which compared the US yield of 2.8% with Mexico 8.5%, India 7.2%, Indonesia 7.3%, South Africa 6.2%, and others. My interest is that these countries are represented in equity mutual funds we own long-term for clients and personal accounts.

(*) Owned in a financial service fund and personal accounts that I own.

Question of the week: 

What return do you need in 2019 for it to be a considered a good year?

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

https://mikelipper.blogspot.com/2018/12/2018-lessons-should-be-learned-weekly.html

https://mikelipper.blogspot.com/2018/12/cash-is-four-letter-word-weekly-blog-556.html

https://mikelipper.blogspot.com/2018/12/news-focus-may-drive-investment-success.html

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Copyright © 2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.