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

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A. Michael Lipper, CFA

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Selecting Time Horizons is Critical to Investment Success - Weekly Blog # 634

Mike Lipper’s Monday Morning Musings

Selecting Time Horizons is Critical to Investment Success

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

To feel successful we play games with ourselves. Both the sports and business pages are filled with “puff” pieces about the extraordinary successes of a limited number of people. We could choose to model ourselves against them, but should we? For a very brief period at age 21 I was disappointed that I, like Alexander the Great, had not conquered the known world. I quickly learned to find more achievable goals, which have changed throughout my life. Those lessons have been applied to the construction of client and personal investment portfolios. One of the advantages in managing portfolios of funds and securities, distinct from having all my assets in a single business, is that I can segregate the single portfolio into distinct time horizon sub-portfolios.

Now I believe it is critical that we recognize that we may be changing speed and direction for up to nine months. Since the 19th of March we have seen average mutual fund performance gains of +37.22%, led by small-cap growth +45.37%. Even “Value” funds on average have risen +30.88%. (As expected, some sector funds did even better:  Equity Leveraged Funds +68.51%, Energy MLP +67.51%, and Precious Metals +51.60%) Above average performing funds did even better than their peer averages. Large gains in a short period of time are historically unsustainable.

Most of these gains were produced early in the last 12 weeks. Market analysts warned that a sustained period of base building performance would be needed for a successful attack at the old highs. However, over the next nine months or so the US stock market is likely to be challenged by other hurdles, as shown below, some not generally accepted at this time:

Medical

1. Two distinct additional bouts of COVID-19 are expected, the initial bout, an echo of the first wave. The second in coming in the fall/winter when we normally face the respiratory flu. Typically, deaths from the flu are in the same order of magnitude as the Coronavirus. What we do not know is whether it will impact the “normal” flu. 
2. There are many attempts at potential vaccines and therapeutic medicines that could help, but some will not work as expected. Furthermore, regulatory and manufacturing/distribution issues will need to be managed.

Political

1. While the mass of investors in most of the world are focusing on the US Presidential election, I as is typical am looking elsewhere. The majority may well be correct in their predictions, but as is often the case the impact may already be reflected in market prices.
2. Whatever the result of the presidential election, the odds favor the following longer-term results: 
1. The winner will not be sitting in The White House in 2025, which will weaken the political power of the President.
2. Members of Congress not planning to run in 2024 will focus on the 2022 Congressional elections, where the sitting President will be of less support and power.
3. Within each party there is a growing split. The leadership in both houses may not have the support of both the younger members and the potential presidential candidates.
4. The political structure of the key congressional committees will evolve and it will not be easy getting legislation out of committee and on to the floor. My guess is that we won’t really understand the “inside baseball” until at least March, with little legislation passed until at least May.
3. The key investment battlefield will be in the House, where tax legislation must start. Additionally, the country will be facing various inflationary threats as almost all federal, state, and local governments attempt to get more money. Businesses will also be trying to make-up for the losses or low income of 2020. Some of the inflationary forces will come through legislation and others through the commercial markets. 

Investment Time Horizons Implications
Each investor should set their own schedule of time horizons. At a minimum they should have three: short, intermediate, and long.

• As a guide, but only a guide and not a requirement, I suggest the short horizon cover family needs, like education. 
• Since we have come out of this recession in reasonable condition, I recommend the intermediate time horizon portfolio be utilized to get through the next recession, which could be worse than the present one. 
• The third time horizon should likely be used for long-term medical expenses and estate planning. 

I might assign 20%, 30% and 50% of assets to each sub-portfolio, respectively. You might be different. I am perfectly willing to accept returns near the bottom for my short-term time horizon portfolio. Others may find that too worrisome. I am not too concerned about the near-term hurdles, unless the results generated by the short-term portfolio threaten the ability to fulfill the desires of the second and third buckets.

Addressing Valuations
In my mind I divide stock price valuations into four buckets: bargains, fair, full, and dangerous. Earlier this year I believed that most prices were in the fair bucket, meaning the upside and downside potential were roughly in balance for my short-term sub-portfolio. We may now have passed into the fully priced bucket, at least until the issues mentioned above are resolved. Fully priced suggests there is some short-term price risk, along with less short-term gain. In terms of my intermediate bucket current prices seem to be in the fair range, with a little more upside than downside. My current view is that my long-term portfolio has much more upside potential than downside. As you can see, the investment horizon dictates a view as to valuation/risk.

Current Evidence
On Friday we saw an expansion in trading volume on the NYSE, with stock prices bouncing in both directions. What I found of interest was the volume of trading in mutual fund management stocks, which jumped. In some cases the companies had good performing funds and in others they were turnaround candidates. Apparently the buyers thought the near-term market favored both.

In the WSJ on Saturday, 76% of the weekly prices of currencies, commodities, ETFs, and security indices rose. Contrary to central bank led pundits, it seems increasing clear we will be undergoing inflation in the near-term future. One of the stock groups not going up and in some cases declining, are REITs. This fits an increasingly popular view that the “new normal” will see less profitable malls and office buildings.

As a contrary indicator, the latest American Association of Individual Investors (AAII) sample survey shows an increase in the number of people bearish for the next six months. This is viewed as positive by market analysts. The AAII sample has three choices Bullish, Bearish, and Neutral, with bearish the clear leader. A more positive view for the intermediate-term can be gleaned from a recent brokerage report showing the stock markets of 73 countries in a base building pattern, measured by their advance-decline lines.

Conclusion
For long-term investors, expect some increase in short-term volatility with some temporarily give back of the extraordinary early Spring gain. Life will become clearer by Spring of 2021. The long-term remains positive.

What do you think? 


 

Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/06/data-driven-reactions-dangerous-weekly.html

https://mikelipper.blogspot.com/2020/06/caltech-data-heretics-go-to-track-for.html

https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings_24.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.