Possible Major Change, Missed by Media - Weekly Blog # 696

 

Mike Lipper’s Monday Morning Musings

Possible Major Change, Missed by Media

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

Isabella’s Jewels

Few knew or noted that Queen Isabella of Spain “hocked” her jewels to pay for Christopher Columbus’s three ship voyage to “America”. While it was known in limited circles that the world was not flat and land masses existed beyond the horizon, they were not accepted and were not even in the thoughts of rulers and important people until substantial “risk capital” was put up.

The media’s attention last week was primarily devoted to the tragic death of ten US Maines, three enlisted service people, including a naval corpsman at the Kabul airport and its implications for the forced US withdrawal from Afghanistan. Most of the world missed the discussions between the Taliban and the Afghanistan poppy growing framers. The Taliban ruled there will soon be no cultivation of drug producing poppies, a devastating blow to farming income and Taliban tax revenue! They suggested other “cash” crops. They did not indicate who would provide capital and skills to develop large scale mining of Rare Earths and other minerals. Clearly, if this were to happen it would have an impact similar to the Spanish discovery of Latin American gold, which led to two hundred years of currency inflation.

From a historical perspective this has great appeal to the Taliban. Almost 1000 years ago Genghis Kahn, in his capture of Afghanistan, diverted rivers and possibly some canals that created the agricultural wealth of the country. From that point to today, the people of Afghanistan have been pessimistic regarding their future.

If this were to happen, it would justify the many empires that tried to control “the world island” (Eurasia) by controlling Afghanistan. In modern times Russia, China, and Britain, saw the strategic importance of the country.  Historically, the US answer developed by Admiral Thayer Mahon advocated for controlling the world by controlling the seas, particularly those that were narrow.

Perhaps the good Admiral’s view should be updated to suggest the control of “space” will control the world. I am not only thinking of space as a place to launch the bombardments of earth. I am also thinking the control of space leads to control of communications. This brings the discussion back to “rare earths” and our ability to communicate, either short or long range. 

Other Voices with Other Concerns

Three thoughtful articles you should consider in setting your long-term investment strategy. The first is the lead article in the WSJ weekend section, about the Administration’s radical broadening of Anti-Trust litigation and regulation. The Anti-Trust legislation protects the consumer, but also includes suppliers and employees, with no protection from a vastly enlarged government sector. These efforts, whether successful or not, will take up a lot of executive time and expense but is unlikely to add to business profitability. Another consideration is whether these matters will alter where business and consumption take place. My guess is we will see a more active US Supreme Court.

A second article which raises concerns is a review of work done by a well respected academic, Niall Ferguson, concerning the path “The American Empire” will take as it loses relative global power, which won’t be pleasant or quiet. Whether he is right or not, the mere thought should be considered, not only from where we choose to live but also where and how we invest.

Barron’s cover story this week is entitled “How to Invest in China Now”, which describes various methods and securities to accomplish this goal. A much more difficult article would have been how to avoid investing in anything not significantly influenced by China. To me, impacted investments include US Government Bonds, local real estate, and domestic service companies. My personal investments are largely invested in the US but are hedged with a collection of mutual funds that invest in China directly or indirectly.

Data Points Casting Future Shadows

1. The Office of Management & Budget (OMB) is predicting 4th quarter inflation of 4.8%. Let’s hope they are wrong. I am more concerned by the slope of the curve than the actual number.
2. Despite the average Precious Metals Commodity fund declining 7% year-to-date, the median commodity fund has risen 23%.
3. In the same period the S&P 500 has gained 20%. (One of the more successful corporate pension funds used to go to cash whenever the market rose by 20%.)
4. The 40-year rate of gain in GDP is 3.1%, but it’s only 2.1% since the recession of 2008-9.
5. In the latest fund data collection week, taxable bonds grew assets $6.7 billion, tax-exempt funds $1.9 billion, and money market funds $0.7 billion. Equity funds had $6 billion in redemptions. (The week ended before Friday’s market.)
6. 86% of weekly price indicators published in The Wall Street Journal rose
7. A personal observation is that the intensity of price increases is moderating and shifting from goods to services.

Traditionally, after the next two weeks businesses will publicly or quietly assess their fourth calendar quarter sales, firming up their budgets for the forthcoming year. My guess is third quarter percentage gains, while good, will be less than the second quarter and will follow a similar pattern in the fourth quarter. Furthermore, there will likely be some delivery short falls in the quarter, both because of transportation issues and other supply-chain hurdles.

2022 comparisons with the current year are likely to be somewhat positive but not great, unless delayed fourth quarter sales come in early during the first quarter. The mid-term Congressional election may cause some shoppers and investors to be cautious.

My views based on history look tame. What do you think?

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

https://mikelipper.blogspot.com/2021/08/another-but-discouraging-look-at-market.html

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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Winning Investment Strategies Shrinking - Weekly Blog # 608

Mike Lipper’s Monday Morning Musings

Winning Investment Strategies Shrinking

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

Premise: Winners are not Good Teachers
In the Northern Hemisphere this is the season where sports fans look forward to identifying the best team to crown as champion of their league. They celebrate the stars that did exceptionally well, but because we don’t like to pick on those that are down, we avoid focusing on the players that performed badly. This highlights the difference between a good sports or investment analyst and one likely to perform poorly in the future. As a contrarian I believe I learn far more from the mistakes of previously competent players than the exceptional winners.

Matter of fact, most winners owe their success to the mistakes made by others, something that is certainly true in military history. Many competitors try to model themselves after recently crowned champions,  but more often than not those who study a broader list of mistakes made by individuals, and their managements will be on the way to becoming future champions. (General George Washington was one who learned from early battle losses.)

Applying Lessons to Professional Investment Battles
Since every investor starts with some cash and perhaps some borrowing capability, all investments and investors are in competition. Most choose to stay in the middle of the pack rather than venturing out to the extremes. Nevertheless, it is not what a single investor or a single investment does, it is what others do that determines the absolute and relative profitability of the decision.

Why is this? It has to do with what is called the weight of money. (A lesson I learned from the real investment professionals at Fidelity.) Prices don’t move on the basis of brain power or information, but on the size of the flows into and out of investments. (This is the fundamental basis behind technical or market analysis.)

Flows follow Performance
Brains don’t move prices, conviction as measured by the size or the weight of money behind the flows do. No one is required to sign an affidavit as to why we do anything, it’s what we do and with what size or force. In viewing different asset classes we can see that the lack of  money going into commodities and some elements of real estate has led to flows into some equities and somewhat indiscriminately to fixed income.

Excessive Flows are Often Late
As with most investment rules and policies they can be taken to an extreme, which might be viewed as an antidote to the weight of money argument. One critical element of flows is who the sellers are at various prices, or for fixed income securities, yields. In many cases the sellers are more disciplined than the buyers. Owners of fixed income products are initially interested in current yield, but those like pension plans are also focused on the reinvestment of their interest payment receipts. When rates are too low they may decide to exit the fixed income asset class with their profits and explore total return vehicles, largely equity-oriented investments.

In the third quarter, worldwide equity funds had net redemptions of $3 billion, bond funds net inflows of $271 billion, and money-market funds net inflows of $311 billion. The smarter sellers may be speaking, especially if you consider that interest rates are among the lowest in 500 years, before the inflation caused by the discovery of South American gold. Even though rates are low, the yield curve is becoming a bit steeper. Currently, the thirty-year US Treasury yield is 2.35%, which may be the “market’s” guess of the long-term inflation rate. Some escapees from high-quality fixed income and some nervous equity investors are congregating in high yield paper/funds. Moody’s (*) has expressed their concern after rising prices in this category, fearing an increase in problems for future issuers.

(*) A position in our Private Financial Services Fund)

All is not Great in the Domestic Equity Arena

1. The US dollar’s rate of exchange is softening, making foreign investments more attractive. 
2. Too much attention is being paid to the S&P 500, which year-to-date is producing a return north of 30%, including reinvested dividends. What is not being noticed is the significant number of stocks producing lower returns, particularly the value-oriented and industrial company stocks found in many portfolios. The latter dealing with lackluster sales and weakening prices. 
3. Low interest rates are allowing companies that should close to limp along and depress prices. 
4. The very volatile American Association of Individual Investors sample survey, a contrarian indicator, showed 44% of investors being bullish vs. 20.5% bearish. (Most readings are in a 20-40% range.)
5. The oldest Central Bank in the world has given up using negative interest rates. Sweden, a very respected central bank, is now no longer one of the few negative interest rate users. I suspect some central banks and investment people with a knowledge of history see higher rates in their future, perhaps much higher.

A useful set of indicators
The New York Stock Exchange (NYSE) currently trades 3,099 issues and the NASDAQ 3,466. Historically the NYSE had more stringent listing standards, so on balance it has older and higher perceived quality. Both had 47 issues that were unchanged last week. The NYSE had 2.6% of its stocks hit new lows, whereas the NASDAQ had 20% hit new lows. The NASDAQ Composite has gained +38% this year and the DJIA +25%. On average the NASDAQ attracts more active traders than the senior exchange and thus may better reflect sentiment.



Question of the week: When was the last time you looked at your fixed income investments with the same scrutiny as you do your stock investments?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/12/faulty-decision-processes-at-change.html

https://mikelipper.blogspot.com/2019/12/investors-are-worrying-about-wrong.html

https://mikelipper.blogspot.com/2019/11/contrarian-stock-and-bond-fund-choices.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

Cash is a Four-Letter Word - Weekly Blog # 556

Mike Lipper’s Monday Morning Musings

Cash is a Four-Letter Word

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

                                   

We have been instructed not to use foul language in polite communication, (think of another four-letter word beginning with “F”). The time to recognize the biggest danger of a word and the concept behind it is when the word is most useful. That is exactly why I am calling to our subscribers’ attention the word “cash”. It looks like cash will be the only positive major investment class in 2018. Stocks, bonds and commodities, as well as some real estate and most currencies, except the US dollar, will all have a minus sign in front of their performance.

Major brokerage firms and various wealth management groups are heralding cash as the preferred asset class. Yes, it is better to make small positive returns than losing money. I have been studying this question for more than sixty years. Recognizing my historic bias based on my experience of using mutual funds, I use mutual funds as my primary filter. Utilizing the latest available data from the Investment Company Institute (ICI), with numbers as of September 30th, 2018, the aggregate weighted average cash commitment for all long-term funds (equity, hybrid, and bond funds) was 3.2% of assets. Most investment objectives have 5% cash or less as a percent of their total assets. This roughly represents under one year’s regular income production. Those reserves would only allow for a few additional names to be added to their portfolios and therefore would not normally be enough to make an enormous difference in performance. Unfortunately, many funds today are having net redemptions, which can only be handled by judicious selling. Many fund managers are concerned about a sudden surge in redemptions at the very same time of weak prices and limited available liquidity and do not want to commit all their cash to the market. There are two exceptions to the relatively low cash commitments, Asset Allocation Funds (18.25%) and Flexible Portfolio Funds (14.14%). While these funds often appear near the top of the performance parade in a declining market, over a full market cycle they are not even close to performance leaders.

Not only do I pound performance data concerning this issue, but I spend time with senior portfolio managers and presidents of fund management companies. There are all kinds of managers perceptive to future market declines and they often tend to be premature in terms of timing. Rarely do they commit the bulk of their reserves anywhere near the bottom. Matter of fact, when the eventual full recovery happens, they often have not fully committed to the markets moving toward new highs. Why does this occur?  Usually the recovery is based on anticipation of favorable changes not currently reported to be in place. Another reason is that emotionally the cash position is providing too much comfort. Buying after a meaningful decline requires some extra intestinal fortitude. Perhaps we should search for fund groups that replace the savior of funds relative assets with a rigorous long-term committed runner.

Recently we were able to restore appropriate equity fund levels to a cash flow account. This is an example of the advantage that some institutional accounts have over a fully committed personal account. Further, I suggested to a younger subscriber that he commit half of his cash reserves over the next six months to meet his retirement capital needs.

This post focuses on cash allocation as an input to a performance focused portfolio, which could be a semi-permanent element of portfolio management. There are other cash buckets such as planned external cash expenditures and purely opportunistic cash awaiting near term deployment. I do not know which cash bucket was used on Friday. Some of the financial sector stocks I follow showed transaction volume being 50% to 100% greater than Thursday’s volume. Friday’s combined NYSE and NASDAQ share volume was the highest since August of 2011. To me, it is more interesting to guess the motivation of buyers who are making commitments than sellers who are giving up. Traditionally, market analysts view this type of transaction volume as stock moving into stronger hands capable of tolerating currently perceived concerns.

For several long-term accounts that have periodic external payment needs, I have suggested that once a cash commitment is made it should be separated from performance analysis. This anticipates the actual expenditure but does not factor it into the asset allocation analysis. 

What to do Now!!

• Determine whether the resignations of General Mattis and the chief envoy to the anti-ISIS coalition are signs of continued political disruption which are of greater concern than trade issues. 
• Recognize that some of the signs of short-term capitulation appear to be evident, including Friday’s spike in trading volume led by stock price declines of former large “tech- leaders”. These stocks fell about 5% on Friday compared to 3% for most other stocks. The greater declines of NASDAQ stocks relative to NYSE stocks were probably the result of less liquid OTC trading books. 
• In a measure of price movements for the week, a chart in The Wall Street Journal showed that only 19 out of 72 price indicators rose, eight of them being currencies. 
• One measure of market sentiment is the often-mentioned American Association of Individual Investors (AAII) weekly sample poll of responses to the question of market direction for the next six months. The current reading showed that most of the sample were bearish or bullish, with a decreasing number being neutral. This is essentially a prediction of continued high volatility. Supporting this view are the 25 best performing funds for the week, six of which were invested in Futures, a leveraged way to bet on fast movements during a short period of time. 

We will only know later if we are at a bottom or not. What we should be doing is following the words of the famous Wall Street trader and a friend of my Grandfather, Bernie Baruch. Explaining his actions before a post-crash investigation committee of the US House of Representatives he referred to himself as a Speculator, which he defined as someone who looks to future time horizons.

Looking to the Future
Long-term value-oriented investors should change their focus away from expected current earnings reports. The great John Neff of the Windsor Fund developed his thinking as to the ultimate earnings power of companies during “normal” times. This allowed him to buy good companies at remarkably low price/future earnings ratios compared to high P/Es on declining earnings. This strategy worked for many years, both for the Windsor and Gemini funds.

Growth oriented investors would be wise to review the current issue of Barrons, which had a long article on a Venture Capital Round Table. I found two items of great interest. The three participants were investing in their expectation of future disruptions to various economic sectors: Financial Services, Supply chain Management, and Farming. To show how far out into the future their thinking extended, there was a discussion on manufacturing products in space, which they saw as a new commercial frontier. As a student of the market, the second thing I found of interest was that one of the three was a successful portfolio manager of an open-end mutual fund, T Rowe Price New Horizons (*). To some degree he and other open-end funds are investing in private companies because of the reduction in the number of attractive publicly traded small and mid-cap companies. Many of entrepreneurial companies are now waiting longer to go public.


(*) A long position is held in client and personal accounts.   



Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2018/12/news-focus-may-drive-investment-success.html

https://mikelipper.blogspot.com/2018/12/investment-memory-friend-or-foe-answer.html

https://mikelipper.blogspot.com/2018/12/worries-2nd-derivative-3rd-degree-and.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.