Transactional Signals - Weekly Blog # 840

 

         

Mike Lipper’s Monday Morning Musings

 

Transactional Signals

 

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

 

  

When my term as President of the New York Society of Security Analysts (NYSSA) expired, I turned down staying on the Board feeling that comments by the former President may not be welcomed. I offered to provide inputs privately when asked. I made a similar offer when I moved on from my position as a USMC officer. With that as a background, I found myself in a somewhat analogous position as a member of the Finance Committee of the Board of the Stevens Institute, where I review an extensive report containing the student managed investment fund. 

 

While the other trustees were highly complementary as to the work of the students, I thought they should get a real education from this exercise. I felt the analysis was lacking any discussion of management and its expected retirement. This was logical, as their time period was the length of the current academic term. To me this was trading, as it was not long enough for an investment period. To me, investment periods begin with five years (roughly the average length of many CEOs). I suggested there was a reasonable chance of a new CEO over the 5-year period.  

 

With this as background, I noted with interest the Barron’s article titled “A Trio of Transitions Will Rock Wall Street”. The three are Larry Fink, Jaime Dimon, and Stephen Schwarzman. The article would have been more useful if it had discussed the likely cause of the retirements: recession, unfavorable regulation, stronger competition, new products/services, shrinking internal political support. With aspects of technology and finance coming closer together, changes in the management of Apple, Microsoft, and the Stock/Commodity exchanges, among others, should be expected within the next five years.

 

I will briefly discuss some of the characteristic changes that may impact stock prices within five years.

 

Possible Recession Risk

Any student of economic and financial history knows that there will be periodic recessions caused by the mistakes of leaders and others. If one looks carefully there is usually a small signal that most ignore. One may be what is happening with the ISM data on the manufacturing side of the economy.

 

The ISM Manufacturing PMI survey for May had a reading of 48.7, a contraction from the April reading of 49.2, a fall of 0.5. The survey for new orders fell to 45.4 from 49.1 in April, a sharp drop of 3.7.

 

Manufacturing employment on the other hand went up to 51.1 from 48.5 in April!!! A possible explanation could be manufacturers hiring younger and cheaper people to replace older and more expensive people. Or perhaps there is a miscommunication between the different functions.

 

Two Positive Signals

In May the S&P 600 small-cap index grew 4.87%, slightly better than the S&P 500, both without dividends. If the market continues to rise on speculation, the 600 will be the leader. In May, seven of eleven sectors in the 600 did better than the 500.

 

Small banks, contrary to their larger brethren, sharply increased their purchases of mortgages on commercial real estate. Local banks quite possibly have a better feel for local real estate value than larger banks, which are hundreds to thousands of miles away.

 

Some Investment Managers Can Repeat Being First among Peers.

The London Stock Exchange Group has continued the Lipper Analytical practice of tracking the best performing mutual funds for periods as short as one month through 10 years.

 

This weekend I reviewed what is usually the toughest competition for the eight periods. Eight is listed as the denominator to the extent the category existed for all eight periods, otherwise a smaller number is listed.  (Year to date, 1 & 3 months, 1, 2, 3, 5, and 10 years). I then looked for fund houses that had two or more entries. The data below shows the results of the major peer groups.

                   # of Repeaters

Peer Groups       Winners   Losers

Large-Cap Growth    6/8       6/8   

Large-Cap Core      4/8       4/8        

Large-Cap Value     6/8       5/8

Multi-Cap Growth    3/8       7/8

Multi-Cap Core      5/8       2/8

Multi-Cap Value     5/7       0/7

Mid-Cap Growth      4/8       3/8

Mid-Cap Core        5/8       4/8

Mid-Cap Value       7/8       2/8

Small-Cap Growth    5/7       4/7

Small-Cap Core      6/8       6/8

Small-Cap Value     8/8       3/8

 

Remember, I was looking for repeaters in terms of fund management companies, as there are fund name changes and portfolio manager changes over 10 years. Additionally, portfolio managers can manage two or more funds. The winners tend to stay with their portfolios, although markets rotate. The losers change portfolios in an attempt to get off the bottom, if they still have a job.

 

A Sign of the Times

Due to a money shortage, the Department of Labor announced it is planning to reduce the number of inputs to their surveys starting in 2025.

 

 

Question: What should we be watching?        

 

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What To Believe? - Weekly Blog # 778

Mike Lipper’s Monday Morning Musings

What To Believe?

 

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

 

 

Preface: Publishing with Intent 

One of the most useful screens used by investigators is guessing the primary intent of what is being offered by the supplier. The most likely intent is to get important consumers to take a specific action, or possibly to not act at all. When addressing an audience of one or more there is a presumption that the “pitch” is to reinforce already accepted consumer beliefs. This is a much more productive strategy for the publisher, as most “pitches” are designed to get the highest number to agree. 

 

As someone who learned to analyze at the racetrack, I feel the need to understand how the majority of the money is thinking about a particular horse, in a particular race, on a specific day and time. That horse is likely to have the most money bet on a projected result. The horse in each race with the biggest bet is labeled “the favorite”. The favorite has the largest percentage of the betting pool and by definition the smallest payoff odds. Favorites generally win more frequently than all other entries. However, they typically win less than half the time, in only about a third of the races. Thus, betting on the favorites does not generally produce enough dollars to make up for the losses in an eight or nine race card day.  

 

This has led me to a mindset of respecting the majority opinion, while choosing to either not bet at all, or to choose a horse favored less than the favorite. This approach has worked sufficiently well that I on occasion use it to bet on securities, choosing non-favorites or outsiders. 

 

This betting technique led me to look through the bulk of the information to understand where most of the money was being bet and if other choices made more sense. I have become a skeptic, which impacts my assessment of the media’s review of the first quarter equity results. 

 

The Favorites View of 1st Quarter Results 

 (N.B. The less than perfect technique of looking past performance for clues as to future results, or at least a better understanding of what is likely to happen.) 

 

These thoughts were before OPEC+ announced a million barrel per day cut and more later.

 

The first quarter of 2023 was viewed as victory for the stock market, with the NASDAQ Composite gaining +18.6 % from the beginning of 2023.  

 

(This view is what should separate the amateurs from the professionals. Markets move to their own rhythm, not to a stated calendar. Like many other market analysts, I measure markets from their highest to their lowest points. The record highest price for the NASDAQ Composite was achieved November 19th, 2022. If one looks at the change from the peak to the close in the quarter, the NASDAQ Composite is down -23.84%. This is significant, because some in the media are calling it a new bull market. I don’t think so, at least not yet.) 

 

There are at least two other statistical ways to see if we are on the immediate edge of a bull market.

1. The number of advances and declines in the last week. There was only one day in the week where there were more advances than declines on the NYSE, and only two on the NASDAQ.
2. Another way to look at advances vs. declines is to look at the percentage of listed stocks that were down for the week. On the “Big Board” 12.57% hit new lows, vs. 17.01% on the NASDAQ. (These are relatively high for the beginning of a new bull market.) 

Many market prognosticators believe a new market phase will be led by different stocks than in the past. For the month of March, the S&P 500 gained +3.67%, although the equally weighted S&P 500 lost -0.88%. The S&P 400 (Mid-cap) lost -3.21% and the S&P 600 (Small-cap) lost -5.16%. (Standard & Poor’s does have an S&P Asia 50 Index, which was up +6.05% in March. 

 

Big Risk: Correction Delayed 

While I doubt we will escape a recession between now and the next Presidential election, we may. However, much more concerning to long-term investors is the need to make major corrections in the economy and society. The following is a list of issues that need to be addressed: 

1. The Federal government needs to stop creating more inflation. It needs to cut expenses and lower restrictions on businesses, which hurt low-income people. For example, reshoring raises the costs to consumers. The bailout of banks through the FDIC raises bank fees, which in turn will lead to fewer low-priced services. Restrictions on energy pipelines increase the cost of almost everything that is transported, even before Sunday’s announcements.
2. Encourage IPOs – Only one of the last 20 Global IPOs was in US dollars, 12 were priced in Chinese Renminbi. 
3. Global lending is down -28% to a 7-year low. Acquisition related financing is down -71%, to 13-year low.
4. Improve management selection in government, non-profits, and business – Choose people with superior operational rather than political skills.

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Question of the Week: Have You Identified the Upside for you?  

 

 

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Will Fund Classification Hurt Your Fund Selection?

Introduction

I have crossed the street to focus on fund and manager selection. In my former role at Lipper Analytical, now Lipper, Inc., a Thomson Reuters affiliate, I wanted to contribute something of benefit for the various fund groups and their directors as subscribers. This was accomplished by creating smaller competitive leagues and subdividing the list by increasingly narrow fund objectives, using total net asset groupings, and measuring performance in five different time periods per weekly report. Over time there were multiple opportunities to be highly ranked.

As a selector on the other hand, I search for a fund or funds that fit a specific need in terms of a combination of portfolio, expense and management skills both at the portfolio and business levels. Absolute performance is critical for some accounts. In other cases relative performance is very important. My concern is that most benchmarks be they securities or fund indices are not structured to meet the real needs of the accounts for which I have responsibility. Part of the problem is that the labels attached to various measuring sticks are not descriptive enough.

Small Caps

Many small cap funds are benchmarked against the S&P 600 Index. Institutional  “gate keepers” or first level filters mistakenly believe the 600 represents a pure play measure of American small cap companies. They are correct that all 600 have their legal domicile in the United States and/or have their main market in the US. According to McGraw-Hill Financial’s survey of the components of their S&P 600 Index, in 2012 these companies have identified that 38.97% of their revenues were generated overseas and perhaps more revealing, 33.2% of their taxes were paid overseas. Clearly there was a great deal of variety as to these small companies’ foreign involvement. In examining the roster I found twenty-three companies that had over 50% of their sales from overseas sources.  As a matter of fact I found four which had foreign sales of over 75%. Since for many years sales outside of the US have been (in local currency terms) growing faster than in the US, I am willing to bet that a number of funds that are characterized domestic small caps are in reality global or possibly international small caps either now or will be in future statement statistics.

The near-term future

Small cap funds may be particularly interesting now. The higher quality small cap funds had a relatively good third quarter performance (see many of the Royce^* funds). I am guessing that the underlying quality companies had significant foreign sales. This is particularly important on this Sunday when the Financial Times reported that the Brookings Institution announced that the global economy is coming back, being led by the richer countries. For the moment the classification of small cap appears to be working. Nevertheless, from a selector’s view point it is a flawed classification.

^* Owned by some of our accounts

Better Classifications

Originally funds were slotted into classifications solely on what the funds’ marketing people claimed they were. Over time this yielded to the language in the prospectus created by the firms’ lawyers. Increasingly their descriptions became so broad that they could do almost anything permissible under the law. We then started to use fundamental standards as to earnings growth, price to book value, yield, market capitalizations and other measures. The data sources for these were the unadjusted financial statement statistics.

As both the fund business has grown and the complexities of the markets have expanded, more useful classifications are needed.  I have already pointed out that higher quality Small Cap funds started to produce better performance in the third quarter after lagging for more than a year. This is clearly an example where one or more measures of quality will help selectors.  Other such measures might have to do with the difference between turnover in dollars vs. turnover in names, operating margins adjusted for net interest, trading liquidity measured against free float and there are others.  Some of these measures would be particularly useful in comparing companies with different accounting systems in different countries.

Bottom line: Pure performance ranking numbers in one period are not an important selection device today.

What screening devices do you use?  Please let me know.

Readers’ Service

In last week’s post I mentioned that Colin Camerer, a Caltech professor that we supported with help for his post-doc students, had just won a MacArthur fellowship, often called a Genius Award.  He sent me his collaborative article in the Neuron magazine, entitled, “In the Mind of the Market: Theory of Mind Biases Value Computation During Financial Bubbles.”  The work shows that during a bubble, the “smart guys/gals” get caught up playing what we used to call “the bigger fool theory.”  Please let me know if you would like me to email the article to you.

___________________

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