On The Way To Casualties & Eventually Riches - Weekly Blog # 918

 

 

 

Mike Lipper’s Monday Morning Musings

 

On The Way To

Casualties & Eventually Riches

 

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

 

Current Situation

In the fog of the latest week there were a few possible clues of changes and pronouncements.

• In November, US manufacturing activity contracted for the 9th month.
• After Friday’s close, an emerging market fund rose +4.99%.
• The value of the US dollar has fallen -6.16% year-to-date.
• Financial Times headline: “Wall Street expects double digit gains next year”.
• Apollo provided a glossy wrapper to the weekend Wall Street Journal, titled “What if the old financial playbook is costing you?”
• The Trump boom is comparable to past expansions, but not yet as big a percentage gain of GDP as the railroad boom of the 1880s.

Each of these bullets point to possible clues for the future, which should be examined by long-term oriented investors and their managers, as this blog will attempt to do.

 

The search for Investment clues

• While we have become a service-oriented economy with high dependence on the skills and attitudes of workers, politicians focus more on the manufacturing sector which has more unions and workers paying real estate taxes and buying lots of local supplies. Thus, manufacturing jobs are more important in Washington than in NYC. I suspect the re-shoring of manufacturing will probably be more automated and will have less employees. Consequently, office holders need to worry about ’26 and ’28.
• The real purpose of announcing tariffs was to force meetings with economic leaders to reduce non-tariff trade barriers. This has led to numerous currencies dropping more than the US dollar. (In my view, this is the wrong way to create more prosperity. We should be raising interest rates, so we are able to absorb the likely increase in bad debts, particularly those held by private capital. Higher interest rates will also raise foreign exchange rates, encouraging foreign lands to utilize more of our exports. A richer world is safer and better for us than a poorer one.)  
• The “street” is predicting at least a 10% gain next year. This year the median US Diversified Mutual fund produced a year-to-date gain of +12.55% and an annualized gain of +10.12% for the five-year period, this is at least 2-3% better than the expected net income gain. The difference is the result of other income and stock buybacks. Currently, public polls suggest investors are not happy with the results.
• Bankruptcies are increasing, particularly in non-listed companies. Private capital raises money to invest in the equity of these companies or to buy parts of public companies. Some of the private-capital is sold to investors as an income producing asset, which often requires a periodic sale of some of their assets. In some cases, this has proven to be difficult because some of their holdings experience difficulties. (While there is some trading of assets between privates, the remaining assets need to be sold to listed companies. This may resemble the old game of musical chairs, where one or more of the ‘safe’ chairs are removed after each round. The remaining chairs will be purchased by the public market, so the private market is dependent on the public market in the end. My concern with regulators encouraging retail investors to put some of their retirement money in private vehicles is that they will be buying into troubled situations.)  
• The comparison of the “Trump Expansion” with the railroad expansion of the 1880s could be accurate. It was a period of speculative, and in some cases fraudulent activities. Many new issues came to market competing with existing firms, which led to price wars and consequent bankruptcies. The era ended when JP Morgan and others recognized that too much competition was ruinous, resulting in rigorous rounds of mergers. Much money was lost and many communities lost rail service.

 

Conclusion

We have entered a globally different world. Investors need to study carefully and invest for the long term, periodically choosing not to invest.

 

Thoughts?

 

 

 

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Significant Messages: Warren Buffett to Step Down by End of Year, Other Berkshire Insights, and Tariffs won't deliver - Weekly Blog # 887

 

Mike Lipper’s Monday Morning Musings

 

Significant Messages: Warren Buffett to

Step Down by End of Year, Other Berkshire

Insights, and Tariffs won't deliver

 

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

 

                             

You have probably already heard that Warren Buffett will step down as CEO of Berkshire Hathaway by the end of the year. Warren announced this to thunderous applause at Berkshire's annual meeting on Saturday afternoon. I am not surprised. At the meeting, which is the first we have not attended in many years, his answers to many questions were more statesman like, recognizing the scope of problems facing both the country and the rest of the globe. He referred to his Father's only political defeat as a Republican Congressman and subsequent re-election. Greg Able spoke purposely, answering an increasing number of questions. He will succeed Warren as CEO.

 

The following brief comments were delivered at the meeting largely in chronological order.

1. Berkshire expects the relationship with Japanese trading companies to likely lead to more Japanese acquisitions, probably in Yen.
2. Berkshire was in discussion for a $10 billion deal recently. Buffett indicated that he thought with Abel as CEO larger deals are likely, with more communication between the units.
3. Currently, the companies are not using AI for Real Estate and they are behind in using it for GEICO.
4. There is a global push for weaker currencies, which is a negative.
5. Life Insurance is different from the Property/Casualty insurance Private Equity is using.
6. Berkshire's stock price has fallen 50% three different times.
7. In the latest quarter, the prices of 21 subsidiaries rose and 29 declined.
8. There were no repurchases of stock.
9. Warren pays more attention to balance sheets than income statements. He is particularly interested in generation of free cash flow. He also believes quality starts from the top. There was quite a discussion about utilities, coal, and fires. The various states and political interests need to decide what they will authorize.

 

Tariffs Are Not the Answer

Far too many people believe that imposing Tariffs on various items of world trade will solve the problems of individual countries. George Calhoun, a Director at the Stevens Institute of Technology and a contributor to Forbes Magazine, raises critical questions in two articles in Forbes. (George and I serve on a board committee at the Stevens Institute.) For brevity purposes I will briefly review the first part of his second article:

 

Will higher tariffs cause inflation?

Prices will rise.

 

Alternative view:

Currency shifts neutralize price increases

 

Mitigating factors: Caveats, Fudges, & Assumptions'

There are at least 14 various measures of annualized inflation.

 

Is it really inflation?

"High prices are not the same as inflation"

There is confusion between the rate of change and the level of prices. (I may include the perception that there is no change in the quality of product or service and time of delivery.)

 

Tariffs affect only a small portion of the "The Consumer's Basket"

(Does substitution change the value of the product?)

 

(I am happy to send the second half of George's article to any subscriber.)

 

The Trump Angle

From the very first time the President introduced the use of tariffs to correct the imbalance of world trade, I believed he was doing it to force negotiations. It is already clear he will change the size of barriers, due to the manipulation of currencies. (See currency shifts above.)

Only the most senior officers can deal with these types of items.

 

 

Question: As usual I would like to hear your views.

 

 

 

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A Rush to the 1930s - Weekly Blog # 875

 

Mike Lipper’s Monday Morning Musings

 

A Rush to the 1930s

 

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

 

 

 

Historic Background

The President comes from a Brooklyn Democrat real estate family background. Many of his actions are similar to FDR’s moves in the 1930s. Like FDR, he is running into opposition from the courts. As with FDR, he wants to lower the value of the dollar. FDR raised the price of the dollar by 60% for non-US citizens and residents, the impact of which contributed to a worldwide depression and was a cause of WWII.

 

In the US

The job market is cooling, and the investment market is changing. As noted by George Gatch of JP Morgan Chase “more than half of total flows into the asset management industry comes from the wealth management segment which is now driven by brokerage firms shifting their sales forces to fee earning investment advisers from formerly registered representatives. While some of these advisers will manage this money through the dictates of the firms, a number of the advisers will act more independently”. (Whether this may increase the likelihood that these assets become more or less “sticky”, we will see.)

 

Equity markets in the US have become less homogenous than in the past. For example, in last week’s trading 48% of NYSE stock prices declined, while 52% declined on the NASDAQ. The volume of trading on the NASDAQ is about 7 times that of the “big board”. (This is a bit misleading as there is more intra-dealer trading to maintain position sizes in the over-counter market.)

 

Historically, one of the least reliable predictions comes from the American Association of Individual Investors (AAII) weekly sample survey. Over the last 3 weeks bearish investors have risen to 43% from 29%, while the bulls have dropped to 33% from 43% and are now a minority.

 

While we do not use commodities as investments, we do follow their prices, which are traded in very professional markets. Of particular importance is the price of copper, which has risen recently. This echoes the increase in the ECRI industrial price index, which rose this week for a +4.97% year over year gain.

 

An Unexpected Turnaround

Long-term investors often examine the potential for a totally unexpected turnaround. I have no reason to expect this change and can think of many reasons for it being improbable. However, the implications are so large that it is intriguing.

 

The two largest economies in the world are the US and China. Many believe the US will continue to grow for the foreseeable future. I have not seen any “expert” who is bullish on China. Nevertheless, through ancient times China was one of the wealthiest countries in the world. Many Chinese work hard and are world class business and intellectual leaders. The Chinese capital markets appear to be in disarray and are suffering meaningful deflation. I recognize that the level of trust between the two world leaders makes cooperation difficult, but the potential value of cooperation for both participants is enormous. Perhaps, our grand or great grandchildren will solve this rich puzzle.       

 

 

 

 

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Stock Markets Becoming More Difficult - Weekly Blog # 841

 

         

Mike Lipper’s Monday Morning Musings

 

Stock Markets Becoming More Difficult

 

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

 

 

 

Picking a portfolio of currently attractive stocks is becoming more difficult around the world, both for the portfolio managers and business managers. This is emphasized by the media’s attention on popular indices, where a small number of stocks are driving performance. The media, marketers, and unsophisticated investors chatter about “The market”. However, today there are multiple sub-markets within the entire universe of available stocks.

 

The job of a good portfolio manager is to carefully select individual securities or funds. No single account should be identical to another. Even if the two started out identical, over time cash flows will create differences.

 

There is a fundamental problem with what most scribes write about securities, as most significant differences result from key critical elements. I will discuss the way the late and great Charley Munger and Warren Buffett might discuss a particular investment. (Both our clients and me personally own shares in Berkshire Hathaway.)

 

Large Caps on the NYSE

Product producers and marketeers are responsible for the bulk of large-cap volume. They are fabricators who repackage raw materials into useable products. The better ones have skills in both purchasing and selling. Currently, the overall stock market view is that many of these product producing companies are in pre-recession mode. New orders are falling behind current deliveries. The market reflects this, with 77% of stock transactions on the NYSE executed on declining prices this past week. By contrast, only 58% of the stocks traded on the NASDAQ were executed on falling prices. In contrast to NYSE companies the NASDAQ has more service-oriented companies, many of which are at an earlier part of their cycle. Furthermore, many of these companies are led by their founders or other entrepreneurs. Typically, Berkshire Hathaway buys companies with good management and keeps them in place. Larger-cap companies rotate some of their managers in training, hoping they will get useful experience at totally managing an enterprise. This experience helps prepare them for similar opportunities at the parent company. Even division heads often lack responsibility for the full business.

 

Playing the Players on the Fast Track

Each week the American Association of Individual Investors (AAII) surveys a sample of their members to get their outlook for the stock market over the next six months. In earlier years I suspect the respondents were relatively conservative senior citizens with meaningful portfolios. In some case they were active investors.

 

Having attended a number of meetings with unidentified “wealth managers” trolling for clients. Professionals pay attention to the weekly numbers for two reasons. The first is their belief in the public always being late. (In truth the long-term record of the public is pretty good, although they are weak at peaks and bottoms.) A second reason is that some professionals want to hear from the “public” to catch the beginning of a trend.

 

This week the bullish members had a meaningful jump to 44.65%, after two weeks at 39%. Bearish readings for the last three weeks were 25.7%, 33.0%, and 26.7%. Most of the time Munger and Buffett buy into a declining price pattern over time.

 

Capital Utilization

Berkshire and a small number of others have generated more capital than they can wisely use in their operating businesses. Today it is more difficult to wisely put capital to work due to the high prices of good properties, and short-term interest rates in the 5.25% to 5.50% range.

What attracted their investment in the past was a good manager looking to add a new aspect to their business. Some of their recent investments in energy were this type of investment. These investments did not result in increased capacity, they were preferably a uniquely new project with a good margin when developed.

 

Business Economics vs. GAAP Accounting

Evaluating what a knowledgeable buyer would pay for a position in the marketplace. Long-term potential earnings power at the bottom of an economic cycle vs correct judgement of a fashionable product. As an example, for years car buyers were attracted to the newest looking cars and during that phase car producers were in the fashion business, particularly if they had creative advertising. This was of no interest to the two leaders of Berkshire, who were more interested in longer term control of critical supply chains. GAAP accounting was of no great value in Real Estate and Pharma. In both cases, winning investments were not what is present, but what they will be.

 

The Investment Game is Changing

There are now a large number of new CEOs and I expect an even larger number over the next five years. Additionally, the structure of the investment sector is changing. For example, Fidelity is attempting to get a fee from ETFs sold through Fidelity’s brokerage desks. If they don’t get it from the ETFs they will likely attempt to introduce a service charge paid by their accounts.

 

It is conceivable that growth in the number of companies moving their headquarters and tax status to Texas will result in substantial growth in listings at the newly formed Texas Stock Exchange. This is already causing national accounting and law firms to beef up or open Texas offices.

 

In the past, the custodian function was considered a good business. But as this activity has become concentrated in a few multi-national organizations, it has become difficult to sell smaller custodian firms. When Ford Motor went public, the tombstone included a very large number of brokerage firms. Most of those names have disappeared, with some merging out while others just went out of business. We have seen the same thing happening to regional stock exchanges, where very few of the remaining exchanges have a trading floor. Instead, there are a computer networks dominated by a few firms. When the next structural recession occurs, it is my guess fewer organizations will be left in business. In the second quarter of 2024, a number of brokerage firms, stock exchanges, and investment advisors are losing revenue momentum.

 

P L E A S E   S H A R E   Y O U R   T H O U G H T S

 

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Manageable Risk - Weekly Blog # 790

 

Mike Lipper’s Monday Morning Musings

Manageable Risk 

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

 

 

 

Uncontrollable and Controllable

Every day in almost every activity we can increasingly be the victims of bad things. That is certainly true of our investment activities. Short and long-term weather, misjudgments of governments, inflation and deflation, as well as other accidents. Essentially, these are beyond our personal control. We can try to anticipate or at least recognize these risks and attempt to take some defensive measures.

 

Controllable risks can be addressed by our own actions. In our investment actions we should be aware of the various mistakes we could make. Both large and small errors should be avoided, usually by being more patient. In making investment decisions it is wise to remember what our changing attitudes bring into the decision process. This summer may be a particularly important time to recognize that we may have entered a new phase of the market.

 

The Game May Have Changed

If you pay attention to what various pundits in the media, political office, or investment circles are saying, we are either in a "bull or bear" market. Quite possibly we are in neither and have not been in either for some time.

 

Market cycles don't follow calendars or the movement of selected indices. Investments don’t move in lockstep with one another either. My particular laboratory is the weekly performance 109 identified mutual fund sectors invested in equity, debt, currencies, commodities, and combinations of largely publicly traded investments.

 

For a two-year period ended Thursday, 83% of the individual sector averages were negative. The 28 sectors showing gains were led by Japanese funds, Energy and Natural Resource funds, Capital Appreciation funds, Alternative funds, S&P 500 index funds, Short-Term funds, and Money Market funds. (Some stock indices also reached higher price levels in this period.)

 

Two Down Years Suggests a Change

We have quite possibly entered a different phase of the market and economy. We may have entered a period of Stagflation. In the last century there were two such periods, the Great Depression into early WWII, and the mid-1970s to late 1980s. The latter period killed a popular view of buy and hold forever. In both periods there were periodic and unsustained rallies of 20% or more for the indices, and much more for individual stocks. Both periods of stagnation were led by government actions attempting to prolong an aging economic expansion. These government actions hurt investor confidence levels and suggested to the public that the economy was better off left alone in returning to equilibrium.

 

Some investors currently have equity money hiding out in bonds and money market instruments. These investors are itching to bring their equity commitments back up to "normal" level. They view declines as good opportunities, which they occasionally might be, but not often. Investors should not be impatient. If we are in a period of stagflation, averaging in with a small percentage during disparate time periods makes the most sense.

 

Long Shot

We all gamble on the future and have two choices about predicting the future-extrapolation of the present or making changes to it. On a day-to-day basis extrapolation is the most likely. The longer the time period, the more extreme the changes. There can also be periodic Minsky moments of great change.

 

What happened in Russia this weekend was a dramatic event that will undoubtedly change what happens in Russia for some time. The long shot is what could happen in how the US is governed. This is not a prediction, but an examination of what could happen.

 

First, we should understand what happened in Russia this weekend. Russia does not have a large, disciplined, and battle trained army. Consequently, it had to use a number of private armies, the biggest of which was the Wagner Group led by Yevgeniy Prigozhin who disagreed with the leadership of the regular Russian army. He claimed the Russian army told Vladimir Putin that Ukraine was going to attack Russia with the help of NATO. He also complained that Russian forces were killing Russian sympathizers in Ukraine. The feud got so bad that Putin ordered Prigozhin be arrested. This caused Prigozhin to send his troops to within 120 miles of Moscow, before some settlement was reached and the arrest warrant was dropped. It was arranged for Prigozhin to go to Belarus, a Putin friendly country.

 

The key point for the US is that Putin now has less confidence in his advisers. When powerful leaders lose confidence in their people, it is often like a disease or plague potentially leading to isolation. As this plague can impact any dominant, semi-isolated person, it could impact the current White House. There are many observers who say the current "Obama White House" and Cabinet is possibly the worst performing the US has ever had. If the President is re-elected, he will be a lame duck, making him an unattractive boss for any rising politician. Thus, major changes are expected, either for career choice reasons or due to the President's wishes.

 

Changes in interest rates will have a relatively small impact on the economy. Considering inflation is generally caused by excess demand over supply driving prices higher. What is needed are customers willing to pay higher prices for more attractive goods and services. This, however, is not what Washington is looking to do,  so there may be a change.

 

Future Outlook Appears Troubling

• After a trend is recognized investment groups often change their published outlook for the period ahead.
• It has become popular to expect business conditions to get increasingly more stressed, with interest rates rising and loans becoming more difficult to get.
• China, the second largest economy is facing its own debt problems, both at the provincial level and in real estate. The big difference is how they are handling a problem similar to that in the US. They are doing it differently.
• The latest US academic test scores show 13-year old's materially declining in reading and math. Perhaps most damaging is a drop in reading for pleasure, which appears to be at a record low.
• The Chinese central government has outlawed tutoring children in order to create greater equality, although parents and grandparents feel differently. A recent article in The Financial Times shows "illegal'' tutoring thriving, at least in the top cities. Tutoring is viewed as a way to improve a student's chance of getting into better schools and universities and consequently getting a higher paying job. When constructing investment portfolios, you should consider the consequence of a decline in US secondary school learning and a decline in college applications while China and other countries show improvement in preparing future leaders.

 

Conclusions

Investors need to recognize change while continuing to focus on long-term goals.

 

 

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Week in Conflict Leads to Buy List - Weekly blog # 764

Mike Lipper’s Monday Morning Musings

Week in Conflict Leads to Buy List

 

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

            

 

 

Trading Didn’t Tell Us Much 

Over-simplification: Buyers largely believe that inflation is the sole problem facing the market and the Federal Reserve will take care of it by managing short-term interest rates. As the stock market went up the first two days of the week, more shares transacted at rising prices. 

 

The next two days saw prices decline in reaction to a greater than expected fall in November retail sales. Department stores led with a more than -2.5% decline compared to an overall average decline of -0.6%, vs. an estimated decline of -0.2%. (Visits to the high-end The Mall at Short Hills in early and mid-December saw a lack of salespeople, incomplete stock, and vacant stores.) There is a second group of investors, some of which were trading and many more not. I call them Realists. 

 

Friday’s transactions were partially misleading in that over $4 trillion dollars’ worth of options came due. Options users often hedge individual securities, exchange-traded funds, and other derivatives. On Friday both the NYSE and NASDAQ traded over 5 million shares on the downside, vs. a total transaction count of 5.4 million shares on the NYSE and 5.5 million shares on the NASDAQ. (Remember, about 40% more shares were traded off the exchanges.)  1.7 million and 2.4 million shares were traded on the upside. (Thus, I am not sure how to interpret these actions, other than them giving us a clue on the size of the speculative market.)  

 

Although the believers will hopefully be right, it does not appear it will be soon. Economists have created an index of leading indicators which are still going down by about 1% per month. The believers, particularly those that are Washington oriented, focus on national numbers. They do this because it leads them to policies where they can harvest votes. The realists are more attuned to measures that track the wealth of the country and the world. This year the aggregate wealth on main street has been rising due to an inflated sample of real estate prices rising faster than public portfolio values have been declining. These people recognize their good fortune but worry about inflation and the decreasing purchase value of their currency. 

 

A leading retail-oriented broker indicated their clients have been buying mostly corporate/municipal bonds and commodities, while selling declining US government bonds. Thirty-year bonds have fallen 35%, the worst in over a century. (Never have they fallen 3 years in a row.) 

 

Commodities are finishing the year as the best asset class for a second consecutive year. Commodities are going up in price because of actual and perceived shortages, both at the industrial level and to a lesser extent at the food level. When demand drops for industrial goods in a dampening economy, some commodity prices will also drop. This is exactly what OPEC+ fears, a fall in demand.) 

 

Brokers also see a sharp increase in the purchase of tax-exempt bonds. Many of these bonds are backed by expected state and local income taxes. These revenues will likely drop when individual and corporate income drops and won’t be meaningfully offset by rising rates for political reasons.

 

Thus, in an attempt to preserve investor wealth and purchasing power, a major portion of their wealth may be exposed to rising interest rates and a decline in purchasing power. After which rates could fall if “The Fed” reduces them. It is exactly the reason I am suggesting long-term prudent investors begin investing a portion of their assets in something that was previously mostly attractive to seniors. 

 

Tactical Reserve Preparation 

This time it’s different in that capital is being temporarily retrieved from risk assets. (The length of time out of the market will be determined by changing investment and personal conditions.) Since none of us know what the future will bring, we should utilize some of our money to defend against the possibility of stagflation, which could last ten years or more. This has happened twice in the last century.  

 

The tactical reserve is best structured by buckets. One bucket being long-term oriented and another short-term. The latter would be kept in locally deposited savings accounts, money market funds, and 2 year or shorter US Treasury paper.  

 

The larger portion, or perhaps the total of the tactical reserves should be invested in Equity Income stocks, an old asset class that is slowly becoming available. For many years these investments were difficult to find due to low interest rate yields. 

 

Currently, 2-year US Treasuries are yielding 4%. In this weekend’s WSJ I was pleased to find 48 stocks out of list of the 1000 largest equities yielding above that number. My filter was common stocks yielding between 4.0 and 5.99% whose price/earnings ratio was below 15x. Every investment has risks and those with yields of 6% or more are believed by the market to have some capital risk. Also, stocks with a P/E above 15 may not have earnings approximately equal to twice the current dividend. Most of these companies regularly raise the dividend at least as much as inflation. Another helpful characteristic is a significant number of shares being held by a family or other interested parties, like some pensions, endowments, and income oriented mutual funds. 

 

While there is some portfolio diversification in the list of 48, it is not as diversified as the broad-based market indices. The largest common denominator on the list is financial companies, with a heavy collection of domestic and foreign banks, particularly Canadian. The list includes Citigroup. Real estate and utilities are also prominent. I was pleasantly surprised to see 3 fund management company stocks I own in order to participate in a growing financial services business. Furthermore, there were names of major holdings in the investment companies I own. I also found some names of stocks I should investigate for inclusion in my tactical reserve or other portfolios. 

At this point the task shifts from security selection to portfolio construction and ongoing management. As we are building a tactical reserve, we need to avoid unnecessary exposure to losses. The first rule is to reduce risks by diversification. The best way to start is to have a beginning portfolio of at least five holdings, which hopefully will grow to ten distinct holdings in time. Pick your holdings from each of the sectors - Domestic banks, foreign banks), non-bank financials, life insurance, property owners, energy providers and servicers, industrial producers of needed products, and utilities. (Some pay dividends in dollars while making their money in different currencies, including commodity aided currencies like the Canadian dollar.) Be careful to limit the maximum single holding to twenty percent of this account.  

 

When operating the account, small cash distributions should be transferred to the cash account. If the prices of the holdings drop ten percent more than the market, stop buying. If prices fall twenty percent or more, consider selling half or all the holding. 

 

Remember, these operating procedures are suggested for the tactical reserve account. A different set of rules and procedures would be more appropriate for accounts having different target dates for payments. The other important thing to remember is that the quicker an investor learns humility, the bigger the ultimate return.    

 

For long-term subscribers who will share their intended use of the list with me, I will make the list available to them.   

 

 

 

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