Another, But Discouraging Look at the Market, Weekly Blog # 695

 

Mike Lipper’s Monday Morning Musings

Another, But Discouraging Look at the Market

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

Academic Approach

In most universities and many CFA courses, the basis for security analysis is an outgrowth of generally accepted accounting principles and macro-economics. This quantitative approach is easy for instructors to teach, as it does not bother with history, sociology, psychology, gaming, and personal judgments. Most importantly, these courses don’t deal with the structures of markets, the varied structures of business operations, personal investments and emotions. These factors are considered in this week’s blog.

Why Now?

I recently prepared a performance analysis for our private financial services fund portfolio through the end of July. For the latest twelve months it gained +57%, +30% for seven months, and +1.38% for July. The point of mentioning these numbers is not to boast, as an index of US oriented financial services funds gained more for the past 12 months, +65%. The reason for mentioning these remarkable results is that they are likely unsustainable, a record of big wins does not go on forever. Some Puritans might believe in being punished for too much good fortune. (I hope not.) However, one could look at the results as the mathematical product of good sales and earnings from the investments, resulting in a significant expansion of the multiple paid for them. The former is what most analysts and pundits dwell on, with the change in valuation only lightly reviewed. After such good fortune I am concerned the multiplier may shrink and this is the reason I am reviewing the outlook for the multiplier.

People

Most developed countries are growing slowly. Japan, most of western Europe, and soon the US have reached peak levels of population, excluding immigration. As societies grow older they buy less goods and somewhat less services, relying more on automation to produce and service what they buy.

Odds are, if we have fewer people permanently employed at large work sites, the company sponsored retirement programs will grow more slowly and in some cases will shrink. This will be somewhat offset by the growth in salary savings plans, 401-Ks and similar vehicles, which in turn will impact the profitability of serving the employed retirement market.

Ease of Entry into Investment Industries

There is a shift going on, investors are being solicited by organizations that are relatively capital light, relying on subcontractors for many of their needs. This will probably lead to lower fees and consequently less compensation for salespeople. Fewer salespeople could lead to lower sales and/or lower turnover of investments. (This is possibly good in terms of long-term investment performance.)

I have noticed that purveyors of public and private securities have one complaint in common these days, there are too many competitors with insufficient backgrounds or other perceived requirements. This is particularly true for those who traffic in private equity/debt instruments, which are becoming available to a broader market. As a member of the investment committee at Caltech, I am impressed with the quality and level of work done by our staff in selecting many private vehicles. They go to much greater lengths of analysis than I am used to seeing in the public markets. I suspect many of the new entrants in private markets will have an expensive learning experience. New players in the private equity/credit markets are entering the game at above market prices with fewer protective covenants, often forcing competitors to follow. This has two impacts:

1. It raises the costs to participate, which hurts all buyers.
2. The raised purchase prices may reduce the ultimate rate of return for the relatively view investments. We have seen crowded stock, bond, commodity, and real estate markets find it more difficult to achieve past profit levels.

Government and Other Regulation

We are seeing governments at many levels introducing new regulation into the investment and fiduciary process. Over time we will see if investment performance improves, with fewer large losses. We live in an increasingly litigious society, which through court cases or practices impacts both fiduciary standards and the investment processes. Regardless of whether these regulatory changes are beneficial, they add to staff costs and other expenses clients pay, lowering profitability.

Talent

Those of my generation and some a few years older entered the investment sector when senior officers were still a bit shell-shocked by The Great Depression. Because of their inbred conservativism, we quickly moved up to the empty middle level jobs, which was a great opportunity and a big ego boost. Our employers and in some case ourselves, later sought new hires with more demonstrated knowledge. In the last quarter of the last century the investment community had the image of hiring the best and brightest young people. By the turn of this century this filter began to change. Increasingly, the brightest with entrepreneurial instincts went into technological jobs, with some going to small companies to learn how to run them. Beyond Wall Street and related industries, not only is compensation more competitive today, but lifestyle options are more attractive than offered in the investment industry. Not only has that increased costs, it has also resulted in accepting less work experience to get good young people. (Some of these projects won’t work out and that is perhaps the best education for the “newbie”, but it is also expensive in terms of resources for the company).

In Summary

There will always be opportunities for some participants and clients to make money in investments. However, due to profit margins likely being smaller, it will cause us to work harder.

Enough Theory- Where are We?

Four brief observations:

1. In the four days before the Biden “Apology”,  NYSE volume was greater at lower prices than at higher prices. This suggests to me that while the retreat in Afghanistan is embarrassing, investors are increasingly concerned about a slowing domestic economy.
2. For the last three years the two largest equity mutual funds each gained 20%. One was “growth” oriented, American Funds Growth Fund of America, and one a bit more initially “value” oriented, Fidelity Contra Fund. This demonstrates that it is the skill of the portfolio manager, not the label attached to their portfolios that produces results.
3. On Friday, S&P Dow Jones published the performance of 32 different global stock indices. Only two were up - US Large-Cap Growth +7% and Equity REITs +1.7%. Selectivity is still the key to making money.
4. Sometimes the action of a single stock encompasses what is happening in the market. In the last two days of the week this was the case T. Rowe Price:

Date     High     Last        Volume

8/15   $212.79   $212.47   679,769 shares

8/16   $215.76   $215.47   497,583 shares

Friday’s gain was not ratified by increasing volume. This stock used to regularly trade in the range of 1-2 million shares a day, with some spikes earlier in the year at lower prices. This suggests there are more buyers than sellers at higher prices or better conditions.

Please share your thoughts privately or for attribution.  

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

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings-are.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings_8.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings.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.

Anticipating Tops - Weekly Blog # 577

Mike Lipper’s Monday Morning Musings

Anticipating Tops

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

Anticipating Tops
As an investor one can react to changes or anticipate them. Most investors tend to react because it is easier to do. The quick reactors tend to move in the direction recommended by their sources, without much in-depth analysis of the “new” information. As a result, market prices often reverse within days, making sentiment measures highly volatile. For example, the American Association of Individual Investors (AAII) polls a sample of its members each week for their market outlook for the next 6 months. In the latest survey only 30% were bullish compared to the prior week’s 43%. The bearish count moved even more, 39% compared to 23% the week before. As a contrarian and a student of history, I will take the bet. (Hopefully I am a better bookmaker than those that set the odds in Australia, U.K. and the U.S.)

With a background of investment analysis at the New York racetracks and a brother who served in Marine Recon in Korea, I attempt to anticipate both tops and bottoms of markets. I am not so bold or foolish as to try and come up with either the numerical top/bottom or the record date. At best I look to get a high profit with lower risk by anticipating the primary direction of the stock market. The remainder of this blog describes some of the elements used to recognize a market top and some attractive places to invest once prices are materially lower.

Top of the Market
Professional historians and particularly military historians believe the beginning of the hostilities in World War I were easily predictable, but not the timing of the movement of European armies. Their certainty was based on the linkage of the two great multi-national alliances and the lack of US participation. What was not known was the flash point. Many believe it was the assignation of the Archduke of Austria by an anarchist, except it took another six months before the battles began.

I am suggesting that we may well be witnessing the equivalent of building alliances, which in due time will lead to the top of the market. Chart analysis of the three Dow Jones averages (Industrials, Transportation, and Utilities) are showing topping formations. The reason to focus on the Dow Jones averages is that until recently they were rising at a slower rate than the NASDAQ Composite, which is dominated by Tech and service providers which had economically been growing faster. However, something has happened to change the sentiment towards the NASDAQ Composite stocks. For example, this past week 40% of the stocks on the NYSE rose vs. 32% on the NASDAQ. More significant is the new high and low lists where there were 319 new highs and 185 new lows on the NYSE, versus 214 new highs and 270 new lows on the NASDAQ.

There are other signs of extrapolation by so-called professional investors. Those signs are like Japanese investors selling yen to buy US dollar assets like golf courses and New York real estate before the “dot com” collapse. Some examples:

1.  The most crowded trades listed in the Bank of America’s Fund Managers Survey were (in order):

• Long US Techs
• Short European stocks
• Long US dollar. 

When a trade is crowded it suggests that those wanting in are paying a premium price to those who are selling. Historically the sellers are more often correct.

2.  This week by far the biggest input to both Exchange Traded Funds and Conventional Mutual Funds were the flows into Money Market funds, especially into institutional funds. (Is this a withdrawal from the equity market and perhaps the high yield bond market?)

3.  Two “name plate” firms are paying large amounts, e.g. $750 million in cash to purchase roll ups of registered investment advisors. (Do they need to do this because their investment records are not attracting enough new customers to meet their aspirations. Golf courses anyone?)

4.  An increasing number of commentators have mentioned the large amount of money being invested by institutions in credit issues that lack the protective covenants of the past.

Looking for Future Winners
As a young junior analyst, I used to look at the list of stocks hitting new lows in order to find companies requiring further examination. A stock on this list, in the collective mind of the market, has a problem. Sometimes it is just sentiment or unpopularity, an actual problem that looks to be permanent, or both. Almost certainly it would have few friends in the investment community. This was hard work because many stocks hit the new low list, although it was occasionally worthwhile. Sometimes the problem was the result of a cyclical phenomenon or management in the process of addressing the problem. I eventually developed a solution to the problem of having too many companies to research and was helped by two realizations.

• There were far fewer names on the new list when the market was flat or rising. 
• Markets recovering from a major break are not often led by the prior market winners, even though they are available at much lower prices. 

The second point brought home the realization that some market reversals are not due to high valuations, but due to something fundamentally changing.

At this stage in my career I use mutual funds as the prime investment vehicle for my clients. Except for financial services companies, which are or could be part of the financial services fund that I manage, I have only a passing interest in individual companies. The exception to this rule are prominent companies in the funds we manage for clients. We will have to see whether “bottom fishing” for future ideas will be as successful using funds as it was employing individual stocks.

There are only six mutual fund investment objective averages showing minuses year-to-date through last Thursday. They are in reverse order:

Dedicated Short Bias         -18.71%
Agricultural Commodities      -6.31% 
Equity Market Neutral         -2.19% 
India Regional                -1.27%
Precious Metals funds         -0.90%
Precious Metals Commodities   -0.39%

Agricultural commodities and India Regional Funds, on a very long-term basis for multi-generational legacy accounts, one would think there are opportunities if the world is to make progress. The other investment objective declines are more the result of political reversals. There are 28 investment objectives, other than money-market and tax-exempt investment funds, that are gaining less than 5% year-to-date. Twenty-three are fixed income and five have an equity-risk component.

Question of the Week:
Do you have an organized way to find new investments?
 
   

Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/05/probable-view-of-next-decline-weekly.html

https://mikelipper.blogspot.com/2019/05/2nd-of-mays-good-lessons-weekly-blog-575.html

https://mikelipper.blogspot.com/2019/04/value-investing-will-be-superior-but-it.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 - 2018
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.