Questions Without Answers Indicate Uncertainty - Weekly Blog # 712

 

Mike Lipper’s Monday Morning Musings

Questions Without Answers Indicate Uncertainty

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

Searching for Direction

Investors gain confidence when they have a clear sense of direction, particularly regarding short-term market moves. They ask a lot of questions in the hope of finding concrete answers. This is increasingly true as markets move closer to the top of a major phase. Thus, extreme confidence, while generally reassuring, is a warning sign of a nearby top. 

Each week I examine lots of data and articles in the media looking for concrete answers, or at least a guide as to direction. This week I came up with some interesting questions, without any good answers. As many subscribers are professional or insightful individual investors, I will serve up the questions with elements of my indecisive views. I am hopeful some will provide answers as a Christmas present and communicate them to me, either for my personal use or to share.

Are Smarter Investors Calling a Turn?

For some time, I have suggested large investors in the NASDAQ stock market are on average brighter than those invested exclusively or mostly on the New York Stock Exchange (NYSE). This is based on the performance of various small-company mutual fund portfolios trading on the NASDAQ since the March 23, 2020 trough. On average this has been the best performing group based on market capitalization (The other groups are large-caps, multi-caps, and mid-caps.) However, year-to-date smaller caps are running in fourth place. There was possibly a change on Friday with its high volume? The NYSE volume was 5 million shares, split roughly 2 million on the upside and 3 million on the downside. On the NASDAQ, total volume was close to 8 million shares, split 4.6 million shares on the upside and 3.2 million on the downside. The NASDAQ Composite has declined 5.53% from its 2021 peak, the most of the three popular indices and roughly halfway through a classic 10% correction.

Does Friday's market action suggest savvy players picking up bargains at low prices?

Commodity Funds Rising Earlier than Expected

Numerous individual commodities are rising due to shortages. The median commodity fund is up +28.79%, while the weighted average fund is only up +3.92%. The reason for this difference is the extreme performance of Energy funds +71.98% and Precious Metals funds -10.41%. Commodity price cycles typically extend to one or more decades, for example from 1996 to 2016. Professional commodity investors did not expect a general commodity rise for at least another five years, after several new mines became operational. The switch to electric vehicles from internal combustion engine vehicles has accelerated demand for some metals, while the interest in currency coins has simultaneously impacted the demand for numerous commodities.

Are these speculative trends going to continue and cause actual mine and mill openings to accelerate? 

Investors Are Finding Other Markets Attractive 

While the US equity market has gained about 25% year-to-date, three other markets are also up over 20%:  India +22.3%, Taiwan +22.0%, and Canada +21.5%. Many investors now see international diversification as prudent, with political turmoil making US investing difficult for at least the next three years. As the economy recovers from various pandemics and tax/trade uncertainties, declining percentage gains in rising earnings will hurt. 

The Fed is Not Helping 

The Fed is basically defining its role as affirming the current situation by looking forward from its present position.

Critical Question: Do you think you will change your investment strategy materially before the next top?

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https://mikelipper.blogspot.com/2021/12/two-contrarian-questions-next-recession.html

https://mikelipper.blogspot.com/2021/12/selections-weekly-blog-710.html

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Was the first week of October the Bull Market?

 Introduction

When everything was falling in price in August, I suggested that one should start to place orders to buy some of the "falling knives" which had the biggest declines, around -20%. These items included commodities and commodity related investments as well as TIPS. My view was that off a bottom there is often roughly a ten percent "relief rally" and this was the easiest money to earn in a new bull market.

In the period from October 1 - 8 , 2015, the following six out of 96 equity oriented mutual fund classifications' investment objectives produced double digit returns:

Natural Resource funds	+ 14.34%
Precious Metals funds	+  13.58
Global Natural Resources funds	+  13.32
Equity Leverage funds	+  12.04
Energy MLP funds	+  11.18
Basic Materials funds	+  10.76

As we know the price of crude oil rose 9% during the week, but there was more to these gains than the oil price pop. While there was undoubtedly a rush to cover various short positions, there were some participants that were sensing the potential for future inflation. More will be needed for the investors in these funds to break even for the year. Even after the double digit gains for the week, five out of the six groups shown above were still down double digits. (Equity Leverage funds were down -9.72% for the year to date.)

Smaller gains were made in the week by 93 out of 96 investment objectives tracked by my old firm now part of ThomsonReuters. Only few of these were able to show gains for the year. These tended to be large growth funds often with meaningful positions in the much politically derided Health/Biotech group. At least Moody's is concerned that we have not seen the bottom of oil prices, they have lowered the credit ratings on five US regional banks which have substantial energy loans outstanding. Being a contrarian I would watch these for an entry point, as I am convinced that in time the underlying collateral will be good on balance.

Even though we are not traders (as we invest for lengthy periods) we need to be aware of others in the marketplace. The risk for the trader is that the double digit that some funds enjoyed fulfilled "the easy 10%" pop expected after the sharpness of the summer declines. Now the trading question becomes whether the August lows will need to be tested in order to put in the low for the year, if we are going to have a meaningful recovery before the US presidential election year.

We Don't Care

As long-term investors we are not very excited by this year's performance unless it has significance in terms of the implications of meeting our clients’ longer term payments needs of their distant beneficiaries. Why am I so relaxed at the moment? First, I believe last week's move was in recognition of some changing attitudes beyond the "oil patch." As is often is the case, I look to the fixed income world for guidance. Domestically, taxable bond fund classifications showed gains, albeit small. These for the most part were funds that trafficked in lower credit rated paper. For people to bid these up they could not be very concerned about a meaningful recession. The other message that I perceived was that the poorly performing TIPS funds gained while other US Government Bond funds showed minor losses.

Foreign Signals

Emerging Market Bond funds, in local currencies, produced the best returns among fixed income types by a wide margin last week, +4.44%; in contrast with Emerging Markets Debt hard currency issues +1.84%. Bond funds which invested in more developed countries gained +1.3%.  My interpretation of these results is, at least for the week, that market participants were suggesting the meteoritic rise in the dollar was at least peaking.

Volatility

The investing public that is glued to the media is fearful of triple digit price changes in the Dow Jones Industrial Average. Using the somewhat less volatile S&P 500 since 1928 according to Factset/StockCharts, the days with a 1% (Up or Down) occurs every four or five days. As a matter of fact I set my computer alerts to only inform me when prices move at least 2% and don't consider action below 3-5%. The New York  Federal Reserve Bank is somewhat addressing these concerns in the corporate bond market that has had bank trading capital reduced by 75%. They maintain that there is ample liquidity to absorb sudden shifts in prices. (Interestingly enough, they did not address what in theory is the deepest fixed income market in the world, the market for US Treasuries. Because of rapid global trading of these instruments through computer interfaces by non-bank dealers and investors, I am worried. During hectic periods of unwinding "carry trades" when treasuries are collateral for borrowings in more exotic paper, I am concerned by the chance for some indigestion.) 

Question of the Week: How are you addressing this market, did this week mean anything?

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Copyright © 2008 - 2015

A. Michael Lipper, C.F.A.,
All Rights Reserved.
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Current Investments for Future Results

Introduction

In our job as professional investors for others as well as personal stewards for ourselves and families we do something today that we want to have a good result in the future. This is easier said than done. To accomplish our goals we need to answer at least two basic questions: 

What are we doing?  Which future?

To help answer these questions, we should be asking ourselves on which time period are we focusing. We have created at least four time spans to put the answers into perspective. These four slices go from:

1. The immediate as defined as the next two years,

2. The following five years to replenish spent capital,

3. The succeeding ten or more years to address longer-term needs for the current decision makers, (endowment issues) and

4. Future periods to aid fulfilling the legacy of the grantor and his/her succeeding generations.

This weekend I seek to apply the items that cross my information screens to appropriate investment time spans.

The current period

To meet current and near-term needs we assume that we can convert our present investments to cash for either spending or repositioning. Too many investors look entirely to current prices and economic conditions. As someone who has grown up in the investment business, I am concerned that the changing structure of the marketplace is not being considered. What I add to my decision process (and what is missing from many strategies today) is a focus on liquidity.

The real price

Portfolio managers and analysts can learn a lot from professional traders. Traders will tell you that a stock or a bond is worth only what it can be sold for. Far too many investors use the last published price without understanding the conditions that led to the price in terms of the relative balance of supply and demand. Quite possibly because of changes of capital on trading desks or floor participants the last published price is quite stale. This is particularly true if you are a potential seller with an over-sized position. A current example of this is the recent drop of 6% in three minutes for shares of Apple^*. According to some, the sudden drop was caused by one or more major players that used algorithms to significantly reduce over-sized positions in tech stocks.

Investment committees have regularly received reports on what specific days to liquidate positions based on average historic volume. Traditionally these reports are meant to show how quickly cash can be raised. Sole reliance on these reports is dangerous. First, liquidity is very much a function of the current desire for the security. Second, increasingly more volume is transacted off the floor than on it and there is no real floor for bonds thus the published volume figures are more an artifact than accurate. I wonder when looking at liquidity whether one should follow the dictum of US Supreme Court Justice Potter Stewart in ruling as to what was pornographic or not: he said he would recognize it when he saw it. To reinforce my skeptics’ view on liquidity let me use the extreme performance of Precious Metals mutual funds as an example.

In the week ended on December 4^th the average Precious Metals fund was off -4.66%, the worst of the 30 equity funds groups tracked. However in just four weeks including the December 4^th period, the average Precious Metal fund was up +10.47% which was the best of the equity fund averages. I would suggest that the fundamentals did not change that much in those four weeks, but the market did.

Another example that attitude changes greater than fundamental changes is the price and volume in the week for the stock of T Rowe Price^*. On December 1^st it closed at $82.61 on reported volume of 753,104 shares. On December 5^th the closing price was $84.49, down slightly from its day high of $84.88 on 1,105,152 shares.

One of the Republican SEC commissioners has expressed concern about the liquidity in the bond market when interest rates start to gyrate. I believe her concerns are well placed.

The focus on liquidity is of particular importance when investing for current returns in the first or operational time span portfolio. If due to spending requirements, securities will need to be cashed-in at the same time as liquidity shrinks, the quicker the near-term portfolio will be exhausted and need to be restored by the replenishment portfolio.

Replenishment portfolio

A well thought-out piece by Marcus Brookes of Schroders Investment Management begins with the following sentence. “We end 2014 with almost every asset class offering investors scant potential return for their risk.” In looking how to build a successful replenishment portfolio I suspect that at some point over the next five years the need to earn a real return adjusted for credit risk will become apparent through a market decline. Having issued this warning, it does not relieve investors of the need to build and manage a replenishment portfolio. While many investors talk long-term they walk short-term by managing their investment against a one to five year time horizon. Under those constraints there is little room for long-term bonds or stocks that are dependent upon substantial new products or massive turn arounds.

While it increasingly looks like we may get a bout of enthusiasm, one would be wise to upgrade the quality in the replenishment portfolios even though during a speculative phase they will probably under-perform, but they will sink less when the eventual significant decline occurs. Moody’s^* is recognizing that “corporate credit has become more risk averse, while the common equity market has become more tolerant.” Surviving investors normally bet with the fixed-income markets, while the traders with the stock market. Both can be correct using their preferred time periods of five and ten years for the investor and quarter, half, and full year for the trader. 

*Owned by me personally and/or by the financial services fund I manage

Legacy investing

Very long-term portfolios are often a mix of companies that benefit from sustainable demand based on demographic and geographic changes as well as disruptive companies. This somewhat hedged mix assumes that there will be evolutionary changes as well as revolutionary changes ahead. The first group of investments should provide sustainable income and capital growth until their mistakes or the disruptions created by the second group of companies hurts them. The failure rate of the second group will be high as they will lack the management skills needed to leverage their disruptive power. The first group will have fewer failures but they will be more painful with less chance for full recovery.

The 85 most disruptive ideas since 1929 were recently published by Bloomberg Business Week in celebrating its 85^th birthday.  One could probably devote an entire business school education trying to understand the power of the 85 disruptive ideas and how few of their inventors or developers produced lasting fortunes. The first three are good examples of the tenet that early inventors and early investors don’t get the major benefit of their disruptive talents. The three are the Jet Engine, the Microchip, and the Green Revolution.

We do not invest in Venture Capital funds to participate in the invention of products and services. Sometimes Private Equity is the way to go as developers build out to an eventual exit strategy. We prefer to use mutual funds which invest in the users of the disruptive forces unleashed in a way that can be leveraged to the benefit of both customers and shareholders.

Conclusion

Pick your time period for judging investment success and that should direct the composition of your portfolio. If you need help, email me.

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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 - 2014

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