Data Performance/Easy.Interpretation/Not - Weekly Blog # 774

 

Mike Lipper’s Monday Morning Musings

Data Performance/Easy.Interpretation/Not

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

 

Simple Numbers Not Useful Answers

The Standard & Poor’s 500 index with dividends has annualized compounded performance reported to be 10.81% since its theoretical inception in1871. The index’s performance since 1965, the period for which Berkshire Hathaway has a public record is 9.9%.  The Buffett/Munger record for this period is 19.8%, or twice the index. I find the three-year record of Berkshire Hathaway compared to the S&P 500 and NASDAQ of greater interest. Berkshire’s compound growth rate was +11.34%, the S&P 500‘s +7.66%, and the NASDAQ +7.80%.  

 

The overall superior Berkshire result produces more comfort to me and clients than just the raw performance numbers. Remember, Berkshire’s combined results include their operating assets and expenses. I do not normally use three-year performance comparisons, as they frequently do not include one or more down years. The S&P 500 had three periods of two consecutive down years in the 58 years, vs. Berkshire which had only one such period. Over the entire 58 years the index fell in 13 calendar years, vs.11 years for Berkshire. (Psychiatrists tell us we feel twice as much pain from a loss vs. a similar gain, which makes sense arithmetically.)

 

Since we manage money for ourselves and others, investment performance is only part of the gain. Our reward is having the proceeds used productively by our beneficiaries or ourselves. If we or others squander the proceeds through bad choices its human impact is the penalty we should calculate in assessing success or failure.

 

Perspective on the last Three Years

On a purely mathematical basis, performance for the last three years suggests we have entered a different period than before. For the five years ended this past December, the S&P 500 index rose by an annualized 9.43 %, which is not a great deal different than its annualized 10.81% return since 1871. However, what is different is the S&P 500 Index growing only 7.66% annualized over the last three calendar years. (Berkshire, because it didn’t have the down year and had its operating side perform better than the security side, produced a compound annual return of 11.34%.)

 

While our accounts benefitted from Berkshire’s performance, the accounts will track a bit more closely to the index. I don’t know how much longer this particular phase will last, we have quite possibly entered a stagflation period. The president and past president have been spenders, comfortable with debts rising faster than the ability to repay it.  

 

If we define a period of stagflation from purely an investment perspective, we had six multi-year periods where the index did not produce a single year rising 20% or more, (1968-1974, 1974-1981, 1986-1989, 1992-1994, 1999-2002, 2004-2008, 2010-2012, 2014-2016).

 

A number of CEOs are changing. In many cases the new ones have strength in operations rather than skills climbing the political ladder.

 

We are also seeing changes at the supermarket. In one of the normally high-priced markets they are no longer carrying the highest price merchandise, e.g. lobster bisque. The weekly list of prices for stocks, bonds, commodities and indices are fluctuating wildly. Less than 10% of prices on the WSJ weekend list rose the week before last. This week 88% rose. To add to the confusion in the securities marketplace, the NYSE saw prices decline for four of the last five trading days, vs. three out of five for the more trading-oriented NASDAQ. For the week, 62% of prices dropped on the NASDAQ vs. only 54% on the NYSE.

 

American investors and their institutions have been selling US stocks but buying both European and Asian stocks. Those buying in the US have favored small-capitalization stocks, including those having more physical assets.

 

Low transaction volume in US stocks is being offset by investors favoring perceived to be less risky investments.

 

We may well be in a phase like the period between the Archduke being assassinated and the formal beginnings of World War I, which was obviously going to happen.

   

Question: What are you looking at to signify a new market phase?

 

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

Mike Lipper's Blog: “This was the Worst Week of the Year” - Weekly Blog # 773

 

Mike Lipper's Blog: A Terrible Week - Weekly Blog # 772

 

Mike Lipper's Blog: Primer on Starts of Cyclical & Stagflation - Weekly Blog # 771

 

 

 

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 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

 

Changing Focus in a Changing World - Weekly Blog # 719

 

Mike Lipper’s Monday Morning Musings

Changing Focus in a Changing World

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

Changing Focus

Securities analysts should come with two perspectives. The majority attempt to read the current minutiae of what companies are saying, with the goal of assessing the current price and the probability of relatively short-term future prices. The second perspective, rarely produced for public or client consumption, eventually pays bigger rewards when correct. 

For some time, this blog has highlighted the relatively unreported negatives concerning the current optimistic outlook. Entering 2022, there are more comments about risks and possible recessions, which while still in the minority of published opinion, has increased in coverage. At this point there are enough bearish comments, so I can move on to the much tougher challenge of finding reasons to be optimistic. The eventual major stock and bond market decline is inevitable, although I cannot identify the time and headlines that will label the decline. Furthermore, I cannot stipulate the length of the bear market, which is normally a function of what owners do, not what issuers do. In other words, from the current lofty levels I am beginning to look across the valley of disappointment to the beginnings of the next expansion. 

I look forward to learning the views of subscribers, both concerning the down phase and the recovery.

Changing Environment 

The future will contain a multitude of changes, many small, but a few unexpected by most will verge on being seismic. At some point in many developed countries, the growing size of government debt owed to non-citizens will be too large. Not only will foreigners refuse to buy more, but they are also likely to push for debt repayment, not rollovers. 

For many Central banks and commercial financial institutions, US debt is a prized asset. However, Mae West may finally be wrong in that “too much of a good thing is wonderful”. In 1990 the Federal Debt totaled $3 Trillion, now in under half of a lifetime it is $30 trillion. Politicians of both parties are responsible for this growth in our children’s and grandchildren’s debt. Interestingly, 35 of 50 states require balanced state budgets. (One can examine the financial health of the 15 states that don’t have this restriction, comparing local crime and inflation.)  While the growing debt is deplorable, it is probably a good indicator of how the government meets its other responsibilities. (Some houses never have a single broken window.)

Looking at the implication of the growing debt and its likely impact on the investment environment in 30 years. The debt will impact our children’s assets and the future value of what our grandchildren inherit. It would be prudent to expect taxes of all sorts to increase. Increased taxes will lower the reported earnings of companies and will probably delay the dividend increases the third generation may be living on. Will it likely lead to lower price/earnings ratios? (Since the 1950s we have generally benefited from rising earnings multiples.)

There are at least two other changes to our investment environment, both positive if one’s portfolio is properly positioned. The first is that winning companies and institutions, no matter what they do, will make progress by improving customer service. Because technology will likely continue to lower the costs to manufacture and transport, the winners will have the attitude of successful service companies.

We are already seeing the third trend that is going global. Year-to-date figures show the US market declining more than 5%, while Brazil is up +10%, Greece +8.5%, South Africa +6%, and Chile +6%. Five other countries have positive equity markets. We are also seeing positive fund flows into Western Europe, Japan, and Emerging Markets. This is probably not a short-term phenomenon. While one can understand a certain reluctance to disclose critical information in patent applications, the number of patents granted suggests a large amount of technology innovation is taking place outside the US. The percentages of patents awarded in 2021 was: China 49, Japan 15, South Korea 11, US 10, and Europe 8.

Changing Companies

Many companies continually evolve, some more dramatically than others. As my primary focus is financial companies, I see some making changes that should impact earnings patterns in the future. Goldman Sachs (*) is developing a retail banking base to fund their investment banking activities. It is my speculation that when Buffett and Munger are no longer involved with Berkshire Hathaway (*), shareholders will own more than one stock certificate. Over time it is reasonable to assume a number of their activities could generate higher stock prices if separated. I also suspect that if the Fed, FDIC, and Treasury come under more restrictive management, a number of banks will split their activities requiring a bank license, placing the more profitable businesses in another company. Watch JP Morgan Chase (*) for such a move within ten years. The financial sector may initiate dramatic changes in how they manage their human relations and work from home activities.

(*) Owned in managed accounts or personal accounts.

Changing Investors

The current effort of some governments to regulate an increasing amount of corporate activity through regulatory bodies will drive more investment into private companies. There is already some level of private market transactions, which will increase. NASDAQ (*) has been active in this, as have a number of brokerage firms and banks. This drive may well lead to more cross border transactions. In dealing with private companies, valuations are often based on verifiable sales data, which includes a price/sales comparison. There is a lot of room for such transactions. For example, the P/S ratio for the Russell 1000 Growth is 5.12X, with the MSCI World ex US Small Cap being 1.05X. 

In terms of investment sophistication, there are private investors capable of protecting themselves as smaller institutional investors. There are times where not being public is better for both the company and its investors. In many cases these investors have entered a second career as a supervisor or confidant to multi-generational family assets.

Question: In your thinking about the future, what changes are you expecting and how will you handle them?

  

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

https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html

https://mikelipper.blogspot.com/2022/01/current-causes-of-concern-weekly-blog.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 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Improve Your Returns: Watch Short-Term and Learn Long-Term

Introduction

With the passing last week of Andy Grove it seems appropriate for me to consider the breadth of thinking in his book Only the Paranoid Survive. While some can be comfortable following Warren Buffett’s words (not his actions) to buy and hold forever, along with most professional investors, my insecurity does not permit me to buy and forget. We worry all the time and particularly when trends turn and accelerate in our favor. This is one of the reasons why I came up with the four increments in the Timespan L Portfolios^® . These require me to focus on both the short-term to make tactical decisions and to learn what are critical lessons for successful long-term investing.

The Short-Term Operational Portfolio Worries

The timespan model for this portfolio was designed for an endowment that has to feed an operating activity over a two year duration, (in practice we will modify the timespans to meet client needs). While we think of this as a short-term portfolio, a number of individuals and institutions perceive their preferred measurement period for the entire portfolio is one year, thus for some, this is a long-term portfolio.

As longer term readers of these blogs have learned, I find a need for excessive enthusiasm to be in place before I start to prepare for a major decline, possibly of 50%.  I am beginning to see some growing enthusiasm. After all of a five week improved US stock market, and rising Chinese stocks and oil prices, I see shopping at the nearby high end mall getting crowded. Parking spaces are hard to come by, shoppers (mostly women) are carrying three or so shopping bags. Stores were reasonably crowded and both the Apple and the Verizon Communications stores have customers waiting.

As an analyst I search for negative indicators as much as positive ones. As long as there is sufficient uncommitted money to equities I know that there is spare buying power that can push prices higher. This is particularly true if the money is being guided by so-called professional, conservative money managers. In a recent asset allocation study of forty large wealth managers' recommendations, I looked at the five most aggressive wealth managers who were recommending that their clients put 60-70% in equities compared to the average of 51% for the forty. Only one manager would put 10% in Emerging Market equities and another sole manager would put 16% in High Yield debt. In both cases the average for the group was about 4%. This was the same level of group aggressiveness in terms of private equity where the five most aggressive had between 10-14%. The commitment to hedge funds on average was 9% where the leaders had 18-25% in these vehicles. Thus the wealth managers in general haven’t been swept up yet by enthusiasm.

Some of the money in hedge funds and other trading vehicles is finding its way into ETFs either on the long side or short side. For the week ending March 23^rd there was a net inflow into equity ETFs of $2.8 Billion which included $1.1 Billion into Balanced ETFs. (It is important to remember that the institutional community has learned that Index ETFs are a cheaper entry vehicle than futures for their hedging and other trading purposes. I will be discussing the impacts of ETFs on the structure of the market places in early April at a meeting of the International Stock Exchange Executives Emeriti.)

I would not pay a great deal of attention to the net redemptions from conventional mutual funds in terms of future direction of the market. In the latest recorded week $1.5 Billion were redeemed, all of it from Domestic funds, almost all that from Large Cap funds. It is my contention that the bulk of these redemptions are in effect “completions” of long-term investment plans prior to funding other needs. This is an old phenomenon which in the past was offset by new purchases of funds that are not happening because it is more profitable for the distribution systems, including registered investment advisors to deal in other products including hedge funds, private equity funds, and to some extent ETFs.

There are some signs of significant enthusiasm which need to be tracked. In the last week $3 Billion went into Emerging Market equities. Some could be short covering. In a recent survey the second most crowded trade was being short Emerging Market stocks which are less liquid than our domestic stocks.

Other examples of rising enthusiasm are the quarterly hockey stick-like estimates of earnings for the S&P 500: 1^St Quarter ‑6.9%, 2^nd quarter ‑1.9%, 3^rd quarter +5.0%, and 4^th quarter +10.6%%. Certainly part of the gains is earnings from the Energy sector going from a ‑98.9% decline to a gain of +10.6. While these estimates suggest a trailing price/earnings ratio of 17.2x and a forward one of 17.0x, the real action is more towards the large and midsize companies found in the Russell 2000 with a trailing p/e of 24.9x and a forward p/e of 22.5x.

Bottom Line For Short Term Portfolios

With the above list of inputs, I still believe that the short-term portfolios should set up a price grid to begin to reduce their risks as the market moves higher. For longer term portfolios they should continue to invest for the long-term and occasionally buy into some opportunities that the market will serve up, but not attempt to market time.

Longer Term Lessons

As much as I question the perceived wisdom from academic sources, like many analysts I am always a student of our environment. As a practical matter it is more difficult to learn from successes than mistakes. Almost every aspect of a success could be the critical element, if you will, the secret sauce that made the success. Most mistakes come from slavishly following the perceived wisdom of reported successes without looking deeper as to why they worked when they did. Probably the toughest part to learn of the art of investing is timing. There is nothing fundamentally wrong with balanced accounts, all equity accounts, private equity funds, and hedge funds. The keys are when to use each of these, in what mix, and what level of patience should be applied. Generally one should use these tool sets when others are not. Most of the time it is a mistake to follow the crowd.

This week I read about an endowment that fired its poorer performing managers after the first seven months of its fiscal year which occurred through the horrible January performance. The group couldn’t take that it was down ‑8.5% and the S&P 500 was off ‑6.6%. The endowment fired their hedge funds and moved into private equity funds. We don’t know what the future will bring but I have serious reservations on the basis of the little bit that we do know. The endowment:

• Probably picked its managers largely on the basis of past performance
• Accepted a popular asset allocation
• Did not understand the cyclical nature of performance
• Did not have sufficient patience
• Elected to do a dramatic change all at once 
  
• Chose to go into the currently most popular asset class with the proceeds of transactions.

I will attempt to follow the organization's future progress because I am always looking for decision makers who have a high percentage of mistakes. These rare negative indicators hopefully will help me and my accounts from making similar mistakes.

Secret Sauces

Far too many investors follow successful other investors and try to mimic what “the experts” do. They don’t focus on the tools the experts applied to their art.  Classic examples are Warren Buffett and Charlie Munger at Berkshire Hathaway, who we will visit this spring. In many ways the tools, not the judgments that they bring to investing is in their annual report. The report contains 67 pages of notes and supplements to their financial statements. I do not claim to fully understand all the nuances that could be found in these pages. To fully grasp the tools that they have used, one would need individual courses in accounting, corporate finance, tax accounting/management, insurance accounting, treaties, various state/federal/foreign legal codes, and various forms of investing. Unless you have a firm understanding of these arts, don’t attempt to play their game. I benefit from both their skills and tools as a long-term share holder.

Other users of secret sauces were the late Sir John Templeton ably assisted by the late Tom Hansberger, both of who were my long-term data and consulting clients. In many respects Sir John was the leading expert on tax code differentials which he applied brilliantly to his personal and company benefit. Tom acted as symphony conductor skillfully managing different personalities as portfolio managers and analysts with global offices and people always on the move. Both understood the sales process and more importantly the sales people as well as how to motivate and control them.

Both of these pairs of artists were much more than stock pickers. Each brought much more to the process of building wealth for themselves and their companies.

Question of the Week: What are the secret sauces that you have seen?
________   

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

Comment or email me a question to MikeLipper@Gmail.com.

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2016

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Comment or email me a question to MikeLipper@Gmail.com.

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2016

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

 

ANSWERS FROM WARREN AND CHARLIE Omaha Highlights

There are legions of books written about Warren Buffett, Charlie Munger and their performance at the Berkshire Hathaway* (NYSE:BRK-A) annual meeting. While I have been following them since the early 1980s, and had the distinct honor to introduce Mr. Buffett to the New York Society of Security Analysts, this was my first visit to the annual meeting. (I plan to return again.) There was not much written in the Sunday paper about the meeting except their support for the Goldman Sachs CEO, but I suspect that coverage will be extensive beginning with Monday. As an exercise for myself as well as the members of this blog community, the following 38 briefs come from my five pages of notes, which I hope share some of the wisdom of these two remarkable men.

INVESTMENT OVERVIEW

One of the first steps in the Buffett/Munger intuitive capital allocation process is to develop their thinking on the potential and likely return on invested capital generated by the businesses being examined.

At this point for Berkshire, capital-intensive investing is a bigger drive than intrinsic (value) investing.


THEIR VIEW OF GOLDMAN SACHS & AFTERMATH

In terms of the ABACUS-2007 deal, based on the SEC complaint, Goldman Sachs* (NYSE: GS) did nothing wrong. The motivation of the other side is not relevant when trading. Berkshire may even benefit from the complaint, as it will probably delay the calling of Berkshire’s preferred stock, currently earning 10% annually.

A new version of Glass Steagall is likely. If Berkshire was forced to put up collateral for its derivative position, it would probably put up its stock holding of Coke (NYSE: KO). At the same time it would demand some additional payments from its counterparties, as they paid for uncollateralized derivatives.

NOTES FROM THE EXTENSIVE Q & A SESSION

In terms of currency exposure, they have exposure on both their assets and liabilities sides. They are bearish on all currencies, particularly those who have to borrow using other currencies.

Each July, Warren Buffett will give 1.5% of the stock to five foundations. The current turnover in the stock on the NYSE is over 100%.

Over the next 50 years there is a high risk of a nuclear, chemical, or biological attack on the US. The risk is low in any given year. (This statement which is not new, it may be a plea for some sort of federal guaranty.)

The list of four candidates to replace Buffett on the investment side changes periodically. The directors are familiar with the candidates, They did well in 2009 without leverage.

It is easier to build a new culture than to change an old one. They failed in an attempt to change the culture at Salomon Brothers.

They think that despite the worldwide size of McDonald’s (NYSE: MCD), the company does a better job of educating its employees than universities do their students.

Munger was the one that discovered Chinese auto parts maker BYD and drove the acquisition of its position.

The various CEOs are paid on the basis of the economics of their business. There is not a Berkshire standard and there is no compensation consultant. Managers are paid to widen their “moats.” Headquarter fees for the 21 employees are not charged to the various operations, but there are capital charges.

The major railroads have been rebuilt over the last 30 or 40 years. The big 4 railroads are allowed to earn 10.5% on their invested capital.

In terms of insurance risks, the company will accept volatile returns while others want to have their earnings smoothed.

Read chapter 12 of John Maynard Keynes’s The General Theory of Employment, Interest and Money, written in 1935.

In 1982 Buffett submitted to John Dingell the only letter in opposition to permitting futures on the S&P 500.

Employees should think and act like owners.

Generally they hope a dollar of increase in equity to be equal to more than a dollar increase in market value.

Warren Buffett, Charlie Munger and some of the board members are visiting China in September.

Thomson (NYSE:TRI) always seems to want a 40% return on capital, a habit held over from its newspaper days.

Munger is converting his IRAs to a Roth IRA.

The federal government will have difficulty in not bailing out the failing states. Due to too-low rates, they are no longer writing new municipal bond insurance policies.

For the next 10-20 years one should want to own equity and not bonds and cash.

Moody’s* (NYSE: MCO) is a wonderful business, but they made a bad mistake on residential housing, They, like others (particularly graduates of business schools), relied too much on models.

Berkshire does not have an annual budget for a fear that various managers would “game” the system.

“We can get along without oil if we must.”

“If scared when others are fearful, you won’t make money in securities.”

In practice they are much more comfortable averaging down than up.

Advice to a new investor: “Get your feet wet with a little failure.”

“Solar panels will get cheaper.”

There will be a truly national electrical grid system.

Their portfolio is often undervalued, they do not own any major future winners.

“There is no better way to get happy than to lower expectations.”

They are blessed by not having an investor relations department.

“One should know the perimeter of one’s circle of competence.”

“One should always keep learning as the competitors are surely doing."

“Very few people fail totally.”

“Follow one’s passions.”

Many of these notes might be cryptic. I would be happy to discuss them to the extent of my understanding of what was said and what was meant.

*indicates securities owned by me or by my financial services hedge fund.
_________________________________________

To Members of Mike Lipper's Blog Community:

For readers who would like to stay current on my uncommon perspectives regarding investing and world markets, join the community by subscribing, at no monetary cost, just your time and interest as well as occasional responses. Simply click the "To Receive Blog via Email" box on the left-side of the screen.

For those already receiving my blog by email, if you would like to recommend this blog to a relative, friend or colleague, the sign-up is located on the left-hand portion of the screen at www.MikeLipper.blogspot.com.