Mike Lipper’s Monday Morning Musings
Stud Poker, The New Swamp Game
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
The never-ending battle between Principles and Principals for the swing votes is entering a new phase that will impact investors. Since ancient Greece’s limited democracy, historians have described the battle between Principles and Principals for political control in capturing a relatively small number of swing votes. Most historians put us at a disadvantage in analyzing the conflict, as we do not have a useful understanding of what really happened. Most historians rely almost exclusively on after-the-fact comments from those supporting various uplifting Principles, because there are easily available texts joining the believers in the nice sounding principles. The other side, regardless of winning or losing most of the time, leave evidence of the tactical moves that led to their success. Very few people produce a contemporary tale of the emotions that drove them to their decisions. At best we have an incomplete outline of what they did. Human Principals are by nature executors and at best leave a history of their successful deeds.
“Where Are We Now?”
Regardless of the final result of the two Georgia Senate races, we will be in an era of divided government. Beneath the surface we are likely to see deep splits within both parties, with different factions positioning for 2022 and 2024 elections. In addition, various members need to build or rebuild the “mother’s milk” of politics, contributions. Many need to be seen as advocates for various local interests, which may conflict with the views of the national parties. It is worth remembering that the last national elections were fought primarily over unattractive personalities rather than uplifting principles. (Remember, US voters often express their negative views by voting for the opposition.)
Elected vs. Unelected
The number of elected representatives in Washington are under 600. The number of decision makers in various government departments and agencies are clearly many multiples of the elected people. Additionally, there is the political crowd, including official lobbyists and so-called “think tanks” following questionable principals. For the most part they are permanent residents in what is known as “the swamp”. Not only will they outlast most politicians, they are experts at manipulating the dictates of elected government.
Despite the egocentric nature of those in the capital, outside forces occasionally impede the political will of the elected leaders. The pandemic is just one such influence. Also both technology and economics increasingly have an impact. But let us not forget what is probably the most powerful force impacting almost everything, demographics.
“The Game”
To understand the game, look at the page count coming out of the so-called “Stimulus Package”. The Democratic Leadership put out a single page of what they believed were their accomplishments. The senate driven bill was in excess over 5500 pages, a clear example of a negotiation by Principals.
The incoming administration looks to this legislation as an example of bipartisan cooperation. The President-elect’s history in the Senate was not based on initiating legislation but working on compromises. The main bargaining chip in the likely compromise with the Principals is often identified with the letter “C”, or a passing grade. Three of the C compromises, often delivered outside of specific legislation, are Contracts, Clauses, and Circuits and Federal departmental judgeships. Large government contracts with sweetheart provision clauses are often favorable in terms of taxes, tariffs, and regulations. They also regularly secure contributions and votes. Circuit or department judgeships are worthwhile endeavors to instill a “friend” in the court.
Stud Poker Model
Watching legislation go through Congress and the White House is similar to the progress of a single game of stud poker. Stud poker, a seven-card game among a handful of people, was popular among political types for many years. It starts with each participant receiving two cards face down and one face up, followed by a round of betting with some players dropping out. It is followed by three rounds of getting a face up card and additional rounds of betting and/or folding with each card. The seventh card is dealt face down, again followed by a round of betting. One can win by being the sole survivor if all others drop out due to seeing both the exposed open cards and their own cards. You can also win by evaluating the face down cards and interpreting the betting and actions of others. The skill in the game is first assessing one’s own likelihood of getting a good hand, by knowing your own cards compared to the possible hands of others and the impact of their betting. There are two ways to win, have better cards than others or convince them that you have better cards where they fail to match your betting. You buy the pot of all that was waged without turning over your face-down cards. Poker is simple compared to Washington politics, with known and unknown cards.
In seeking a legislative compromise it is important to identify the strength of conviction that a useful benefit can be secured in reasonable time and determine what has been promised to others. Often, the more experienced legislators or their top aides can create an advantage that more junior Congressional members are unable to.
Let the games begin!!
What to Do?
As with more questions, it depends on your goals, measurements, and tolerance for disappointment. The answers for most of these questions is very dependent upon the time-period and measurement applied. The shorter the time-period, the less influence of timing decisions. Based on past experience, there have been 25% declines in one year and 50% declines in a couple of years or more. It is the measurement method which causes the most trouble in my opinion. In choosing between a very limited number of alternatives it is easy to measure absolutely, although with a large number relative performance is often more realistic. Most measure by comparing against a mathematical average, which is heavily influenced by the extreme performers. The more mathematically oriented may use the middle result or median in an array, which is preferable to me. With a large universe of competent players I prefer to subdivide performance into quintiles, avoiding the knife edge of quartiles.
I tend to view the performance within any quintile and particularly the third quintile as almost random, with a small number of extreme results being difficult to repeat. When managing in a competitive league that encourages shifting managers frequently, data from the current best performers is often used, not by me. For accounts having stringent absolute payments requirements, I prefer to measure against absolute and relative capital preservation.
Now?
I prefer to work with long-term investment horizon accounts, where demographics, discipline, savings habits, intellectual-honesty and productivity of the labor force tend to structure my working framework. I don’t make any strategic changes, as some tactical changes will be required due to fundamental changes within the specific investments themselves.
As distinct from the long-term accounts, those that have effectively fixed or semi-fixed payment requirements need to balance the risk of reduced actual or anticipated payments with the generation of future sources of income production. Depending on the specifics of the account and our perspective, the mix between the two motivations is within a 30-70% mix. (This is not an essential prescription to the standard balanced fund’s stock/bond ratio, because both bonds and stocks may have capital risk and appreciation opportunities.)
As we enter the new year, the first of a radically different administration and a shifting power base, investing for the short-term in a competitive environment is going to be difficult. At times investments are priced cheaply in terms of their fundamentals, whereas at other times markets price securities near their probable top. In the last week of 2020 I don’t know whether we are closer to one extreme than the other.
As often the case when I am faced with a decision, I attempt to follow a sales prescription from Ben Franklin’s commercial activities and make a list of positives and negatives. Some salespeople convert these lists into a form of a balanced sheet, which surprisingly almost always has more positives than negatives. Before producing my lists I should identify my anti-momentum bias. Much like at the racetrack, I don’t have to bet on every race or market condition and the bulk of the money I am responsible for is long-term. (Think beyond this decade.)
The US stock market has fluctuated in a relatively narrow trading range this autumn/early winter period. Only after a material market move will we be able to determine if this was the distribution of risk from smart investors to less smart, or an opportunity for smart investors who perceive the near-term future as being materially better than what we have seen in the last four years. Thus, one can say that the current market brings together sceptics and believers.
As the volume of transactions compared to the number of shares outstanding is low, one can see that there is not an overwhelming consensus view by market participants. Most of the money is invested for the long-term, at least beyond the incoming administration’s period in office. In the last two weeks of 2020, sceptics are selling to protect their capital gains from possible changes in tax rates on income and estates. s Buyers perceive an expanding domestic economy and a less turbulent world.
Positives (Random order)
- The crowd at The Mall at Short Hills appeared to be larger on the first shopping day after Christmas than the days before the holiday. We guess the crowd had to line up and be temperature tested before entering big brand clothing and jewelry shops. The longest lines were at the Apple (*) store. Restaurants were busy and had lines, indicating that shoppers were committed to spending hours shopping.
- I believe we are in a somewhat new investment era because of COVID-19 and global technology’s impact on consumption, suggesting our favorite numbers are out of date or out of scale. Key relationships between risk and reward probably remain reasonably constant, but not their number identifiers like P/E, yields, stock/bond ratios, turnover rates etc.
- Shortages permit big price increases e.g., intra-Asia shipping container prices being up 450%. On a broader base JOC-ECRI Industrial Price Index is up 23.87% year over year.
- Long overdue stock leadership rotation in favor of small and midcap stocks will bring more capital into a needed sector. Tech focused stocks have returned temporarily to leadership.
(*) Personal position
Negatives
- 62% of this week’s WSJ roster of prices declined.
- A consumer confidence survey, expecting a +97% reading, came in at 88.6%.
- Some strategists see meaningful risk in the Middle East and China. In the former case, strained budgets will force risky expansions. In China’s case, a further crackdown on debt creation is expected.
- The Biden administration relying on people for material economic expansion based on their Obama Presidency experience.
Subscribers, please remember the two iron clad rules of investing:
- The only guaranteed product of the market is to create humility.
- Surprises happen because most don’t expect them.
Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/12/mike-lippers-monday-morning-musings.html
https://mikelipper.blogspot.com/2020/12/searching-for-surprises-weekly-blog-659.html
https://mikelipper.blogspot.com/2020/12/an-investment-dilemma-with-possible.html
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A. Michael Lipper, CFA
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