Investors, Politicians, & Other Children - Weekly Blog # 745

 

 

 

Mike Lipper’s Monday Morning Musings

 

Investors, Politicians, & Other Children

 

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

    

 

 

Most investors, politicians, and other children act as if they are the only people that have had to deal with behavioral challenges. However, there is very little in life that is totally new, only the packaging has changed.

 

For example, how should one measure progress, and should it cause action? Most of us have some level of confidence in reported numbers, although numbers are an abstraction of a reality, not reality itself.

 

We are all counters from an early age, and since tradeable money was created have tended to count many of our successes and occasional failures in monetary terms.

 

The problem is the value of money is in the eyes of the beholder. One hundred million Confederate dollars has very little, if any value today.

 

Those dollar bills were on the losing side of a painful war, but we have been on the losing side of an age-old battle since birth. That depreciating value is called inflation.

 

The crux of the problem is the creator of this vehicle of exchange is also one of its largest users. Furthermore, the ruler of the mint or printing press is in a position of strength due to support from the right people. The easiest way to keep their loyalty is to pay them. In imperial Rome it was called “bread and circuses”.

 

In many Roman cities and towns, the amphitheater was larger than the nearby fortress. These were the entertainment centers for the populace who had enough food to eat due to an efficient agricultural system with well-engineered aqueducts.

 

I find it revealing that today’s name for giving money indirectly to the population is derived from a Latin word for stimulus. In earlier days it was called a bribe.

 

When a long-distant trader, Marco Polo, worked along the long Silk Road (1271-1295), the most advanced society was the Chinese empire. It developed gun powder and later developed paper money. Not surprisingly the empire had a large government, with examinations for jobs.

 

From my standpoint, smuggling silkworms back to Europe created a market-based exchange with a sounder form of money, especially when compared to their traditionally weakened currency. This is the way he delt with inflation.

 

In the thirteenth century the Europeans were somewhat protected against inflation due to small indigenous silver mines whose content went into their currency. This lasted into the next century and was replaced by gold and silver produced at low wages in Latin America, starting about 200 years of inflation.

 

When the steady stream of gold dried up the overseas colonies of England and other European countries became too expensive to maintain without substantial taxes. This is the reason a political group in England was not disappointed with the result of The American Revolution.

 

Confidence in the Future is Low

There are a plethora of signs showing this lack of a defined future:

• What are yields on US Treasuries saying? 2-year Treasuries are yielding 3.25%, 10-year Treasuries 2.84%, and 30-year Treasuries 3.07%. The 2-year is inverted relative to the 10 and 30-years!!

•  All 3 of the AAII survey predictions for the next 6 months are in the 30-39 % range.

• While 53% of the DJIA companies were winners for the week, the DJIA lost value in aggregate points. By comparison, only 40% of the companies in the Transportation index were winners.

 

• The JOC-ECRI industrial price index dropped 5.15% year over year.

 

• Exchange traded equity funds continued to suffer redemptions, led by growth and value funds.

 

• Liz Ann Sonders, the highly respected chief strategist from Charles Schwab is not bullish because she has not seen the market capitulate, as would normally be the case near the end of a bear market.

 

My Views

I have been searching for reasons to be optimistic for our long-term investment accounts, as after every bear market there is a bull market.

 

I agree with Richard Bernstein that bull markets don’t start with narrow leadership.

 

I believe economic and market cycles are not just number exercises, which you might be led to believe after reading columns from the various pundits.

 

I believe cycles are critically needed to address severe imbalances, not just trading opportunities. In previous blogs I have listed troubling demographics quality of schooling, healthcare, military strength, and leadership.

 

As I do not see these imbalances being addressed, I am afraid we will experience one or more recessions. There is a popular hope we will avoid a recognized recession, or only suffer a mild one.

 

If that were to happen, it would not likely sufficiently address our problems. I have no doubt our politicians can continue to produce a smoke screen to hide the issues. The current proposed legislation is an example of this, almost guaranteeing a major recession in a couple of years.

 

If that were to happen, much like during Paul Volcker’s tenure where he had two recessions, there would be substantial risk of a needed recession with very high interest rates.

 

I look forward to a new bull market with some answers to our problems, even after that experience. Our families will need one.

 

Please comment.

 

 

 

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

https://mikelipper.blogspot.com/2022/07/weather-market-economic-and-political.html

 

https://mikelipper.blogspot.com/2022/07/beware-of-cheap-seek-fair-slowly-weekly.html

 

https://mikelipper.blogspot.com/2022/07/time-to-be-contrary-weekly-blog-741.html

 

 

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When the Stock Market Sleeps - I Get Nervous

Not only have the popular US stock market averages been flat for a period of twelve years, the recorded volume this summer has been scant. The so-called fear index, the VIX measure, is producing returns significantly below averages. 

In another sign of lack of concern, the decision was made at a recent investment committee I attended that a specific inflation defensive fund was not needed. (If you believe the US government’s statistics, the latest available all items count would be a minus -0.16% for the month of May and a core rate of 0.01%).

Somewhat more ominously there was praise for our committee’s market index fund selection, with the question as to why we should pay the high fees for hedge funds that are not producing better-than-market results. In another investment committee meeting it was suggested that many institutions are buying hedge funds directly and redeeming funds of hedge funds. (If the latter approach gains momentum it can hurt the expansion plans for the number two profit contributor to Legg Mason, a holding in our private financial services fund.)

What makes me nervous is that there are lots of facts and opinions that are crying out for significant changes in portfolios.

Start with the negatives

A recent piece by Moody’s* chief economist, John Lonski entitled “Global Slowdown Menaces Ratings,” focused on the recent plurality of downgrades as opposed to upgrades both for High Yield and Investment Grade bonds. As reported in my previous blogs, the appetite for yield at the moment appears to be insatiable. In the current quarter there have been 43 downgrades and 20 upgrades of high yields, and a 13 to 3 ratio for investment grade paper. Remember that one of the criticisms of the credit rating agencies (for understandable reasons) is that their findings are late relative to the market. The sellers and buyers of bond funds, particularly of high yields, do not appear to be following the changes in ratings. As an equity analyst I have been trained to think that the bond market senses trends before the stock market. The ultimate payoff with bonds is the return of principal with interest, as distinct from the equity market’s hope of future capital appreciation.

*Moody’s is another holding in my private financial services fund.

In one of John Mauldin’s well-written weekly letters he suggests that we may be approaching a Minsky moment. Hyman Minsky, a well-known European economist stated that stability leads to instability. After a period where the normal is flat, there will be a violent change. The key to this thinking is that something will dramatically change people’s views as to when the current supply and demand mix will abruptly change, which is easy to believe in our 24 hour news cycle world.   

In another letter John Mauldin mentions that the real problem for the euro long-term is France, which I have felt to be the case even before the last unfortunate election

One of the advantages to investors of the flat performance of the VIX futures, particularly if we do experience a Minsky moment, is that hopefully both the academics and the marketers will stop using volatility as a measure of risk. To me, risk is the inability to meet future payment goals for an investment or portfolio, not whether the return is calm or fluctuates. This belief can be a problem for the sleep patterns of trustees.

The positives that no one believes

If you ask most people about the progress of the market in 2012, they will say they don’t believe that we are up low double digit returns by mid-August. These returns would more than fulfill the annual requirements of most institutional funds; as a matter of fact the returns are close to double the needed returns for the more sensible institutions.

Richard Bernstein, now independent from a career at Merrill Lynch suggests that Bull Markets begin out of a malaise of fear. Investors are fearful of facing an unpopular election in the US as well other unpopular and unknown changes in governments for over half of the world’s GDP. In addition, the so-called “fiscal cliff” comes due to challenge the US at the end of 2012.

There are no apparent signs of valuations which are historically too high. (I would suggest that the excesses are in the bond market where the manipulating central banks are depressing interest rates. As we know, eventually even the manipulators run out of money.)

One of the more bullish pieces that I have read is by Seth Masters of Alliance Bernstein. In his view of a normal market expansion he sees a Dow Jones Industrial Average of 20,000 in five years. Even on a lower multiple basis, Masters predicts the market will reach this level in ten years. What is significant about this piece is first that it is coming out now in a period of malaise, second it is not from a promoter, or a Dow at 38,000 proponent,  etc., and third, if true a move from here to a 20,000 DJIA would fulfill lots of investment requirements. (As long as inflation remains tame.)

Perhaps the single most bullish piece that came out this weekend was the disclosure of the portfolios of Paul Ryan and his wife Janna. I do not know who selected the list of well-known and generally sound mutual funds. What is significant to me is that the potential “second family” of the US has been well advised and has a spread of funds that are appropriate for the current world. If Mr. Ryan becomes the Vice President or stays as chair of the House Budget Committee, we will have someone in a high place that has a sound outlook for his and hopefully the country’s investments.

Sleep well, but not too well.

Corrections
 In last week’s blog I mentioned a recent study of one account that we manage and said that there was not a single decline in 2012 through July, in the list of 47 funds. The actual number was 37. My apologies for the error. 

Second, for an unexplained reason some of our email readers received a version with the initial letters of some words doubled. If that happens again please let me know and we will send out a corrected copy. 

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