Are History & Economics Books Closed? - Weekly Blog # 953

 

 

 

Mike Lipper’s Monday Morning Musings

 

Are History & Economics Books Closed?

 

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

  

 

 

The Reward for Analysis is Prediction

The payoff for analysis is plausible prediction, whether correct, wrong, or part of each. As this is an investment guess as to the future, it will at worst beget an emotional reaction, or possibly thoughtful disdain. On the other hand, it might suggest a future looking distinctly different than extrapolating the present, including the desires of those presently in power.

 

This may be an appropriate time to look forward to something different than the present and begin investing on the chance something different happens. The reason this is an appropriate time to express these thoughts is that those in power are only focused on the immediate and have closed the political and economic history books.

 

The following items point to a different kind of future:

Political Disruptions

• There is hardly any national government that is universally popular, which is different than being tolerated by a diverse population. At the moment the majority is not unified and lacks dynamic leadership.
• The current renter of the White House is waging a war which he believes he can end and in so doing can generate a political victory for him and his party. He should study the greatest UK leader of modern times, Winston Churchill, who lost power immediately after WWII to the Labor Party.
• While office holders are getting older, voters are getting younger and richer.
• While some media are controlled, increasingly more are not. Anyone, anywhere, may be able to reach individuals and groups.
• Both ancient Greece and Rome lost total control to an enlarged population. China had similar problems.

 

Financial/Economic Changes

1. The impact of air conditioning is coming to Europe, Asia, Africa, the Middle East, and Latin America. (In the US, the one thing the founding fathers did not foresee was the federal government existing in the humid swamp of Washington DC.)
2. The population of the US is likely to shrink without immigration, causing the national debt, social security, and Medicare to fall under pressure.
3. The rotation of the relative ranking of investment performance is likely to change. Over the last ten years only domestic and international science and tech funds have beaten the average large-cap growth fund average. This is from a universe of over 100 mutual fund category averages. (It is my bet that this will not be the case over the next ten years. None of the initial stocks in the first DJIA are in the current index.) The common denominator of successful funds is essentially the inclusion of computer-oriented products or services with substantial sales in the US. It is this concentration in a dynamic global world that will eventually lead to a rotation to other segments of the market.
4. Evolution has been part of life on our planet since the beginning of time. I believe only change agents have a chance of surviving longer. My accounts have two good examples of successful change agents, along with some mistakes. (These are not recommendations that should be made with complete knowledge of an investor’s needs, wants, and understanding.) Each of these companies began life pursuing other businesses and made significant purchases. Berkshire Hathaway started as   a money-losing textile mill. After Warren Buffett’s hedge fund bought it, Charley Munger taught him how to buy good companies at reasonable prices, which resulted in them building a great holding company. Recently, Warren appointed Greg Able as CEO of the firm. He is in the process of slowly turning Berkshire into more of an operating company by doing the following things:

• Appointed a Senior Executive over groups of single companies.
• Purchased Alphabet stock for cash, making it one of the firm’s 5 largest holdings.
• Purchased a home and community construction company and combined it with an existing builder of factory-built homes and a mortgage provider. (The country needs a major increase in the building of homes, and they will be part of the solution.)

Berkshire has not said anything yet about paying a dividend, although I think they will do so in a number of years. My thinking is based on Mr. Buffett’s statement that he and Charley were not running the company for the shareholders, but for their heirs. (It is already happening. I believe that a good bit of the stock owned by individuals for 50 years or more has been inherited on a step-up basis. These new owners of the stock will have different attitudes toward the company as they consider their own retirement needs. In order to keep this growing number of shareholders happy, it makes sense to pay a reasonable dividend.

 

The second stock already pays a mid-level dividend. The Thomson family controls roughly 70% of all shares of Thomson Reuters through their private holding company. They have made a number of dissimilar investments over time, including a commanding position in the North Sea oil field. Their principal business today is distributing critical data to law firms, accounting firms, corporations, and governments in the US, Canada, the UK, and Latin America. Thomson is the largest provider of this type of data, and they have taken their time converting their products to utilize “AI”. Their customary careful management has recently introduced “AI” driven products which have been well received, making good progress with both old and new customers. (Disclosure: For a few years Thomson owned the data of my firm, Lipper Analytical Services, but they recently sold it to the London Stock Exchange Group.) Thomson Reuters is similar to Moody’s, S&P Global, and other commercial data providers that we own.

 

Working Conclusion:

Change is inevitable and risky, but necessary, and worth the risk most of the time. 

 

Please share your thoughts

 

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

Mike Lipper's Blog: Dead Cat Bounce > Last Chance - Weekly Blog # 952

Mike Lipper's Blog: Long-Term Money Via Telescope, Not Microscope - Weekly Blog # 951

Mike Lipper's Blog: Before Focusing on Shorter-Term Reactions - Weekly Blog # 950

 

 

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 – 2024

A. Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

 

 

Caution: This Time Is Different - Weekly Blog # 825

 

      

Mike Lipper’s Monday Morning Musings

 

Caution: This Time Is Different

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

   

 

       

Warning

The standard excuse for breaking the historic pattern of following precedent is the current situation being fundamentally different than the past. The break in historic pattern makes it appropriate to not copy the past pattern of each substantial rise and decline.

 

The problem with the old pattern is that it is two dimensional. If it is going up, it will next go down. However, the next driving direction may be diagonal or a collection of reversing diagonal moves.

 

Worst News for The Leadership

One or more diagonals will upset political leadership, leaders of business, military, non-profits, education, and others in a position of responsiveness. One example is the CEO of Walmart, the largest retailer in the world. He noted that in the general merchandize category the US was in a deflationary price trend. However, in the grocery category the prices of some items like eggs, apples, asparagus, blackberries, paper goods, and cleaning supply were simultaneously rising. (The first four items are classic supply and demand oriented. The last two have significant manufacturing cost elements in their cost structure.) Is Walmart suffering from inflation or deflation?

 

There is a third input caused by substitution. Packing fewer items in a smaller package lowers the price but increases the frequency of purchase. Still another substitute would be lowering the quality of goods and services sold, such as producing less powerful batteries for hand-held devices.

 

Consumers and Investors Are the Real Losers

The unsuspecting real losers are consumers, investors, and any on the receiving end of actions served up by organizations relying on classically trained economists. They make these judgements about the quantity of goods and services. (Have you noticed the dexterous taste of meat and other agricultural products due to cost-cutting providers!)

 

There Are Other Numbers that Drive Investment

There are often other reasons companies are acquired. This week it was announced that Capital One, a Virginia Bank with a very large credit card business, is attempting to buy Discover Financial (*), also a very large credit card bank. If permitted, the transaction would create a card processor as large as Mastercard and Visa. This could change the entire credit card and consumer bank businesses.

(*) Owned in personal or managed accounts)

 

On Saturday, Berkshire Hathaway (*) issued its annual report and shareholder letter. (A copy of my internal reaction to the letter is available to our blog subscribers by sending me an email at AML@Lipperadvising.com) The shareholder letter mentioned that their BHE owned utility served the population of ten midwestern and western states. (To the best of my knowledge this is an unrecognized and unused asset which could be of great marketing value in the future. It is the sort of non-balance asset that represents hidden value not tabulated in government records.

 

Another example of a business asset transforming into a financial asset capable of changing the nature of competition in the securities markets surfaced this week. This was captured in the following headline from the Financial Times “S&P Global nears deal for Visible Alpha in effort to compete with Bloomberg.” (Shares in S&P Global are owned in proprietary accounts.) Visible Alpha collects research reports from major Wall Street firms and distributes them electronically. It thus attaches additional value to research, beyond that provided by the originating firm and their direct clients. If the deal goes through the consortium of firms will probably pass the proceeds back to the issuing houses, partially converting an expense item to a capital item.  

 

A “Smart Money” Bet on Market Direction

Regular readers of this blog know that my primary investment academy is the racetrack. Always trying to improve my results I learned to look at what I thought was the “Smart Money” at the track. Applying that principle to investing I see a decline as the next major move, for the following three reasons:

1. Both the Chairman and President of JP Morgan Chase have recently sold some of their shares. In the case of Jaime Dimon, it is his first recorded sale. Since he bought some shares in the public market, I assume they will represent a portion of what he sells. The President sold some earlier in the year.
2. Berkshire has been a net seller for the last four quarters, including two stocks that we own, BYD and Apple.
3. Many industrial/service companies have issued layoff notices and/or have delayed start dates for new recruits. These are significant. My guess, many of these companies have found it difficult to hire the right people over the last couple of years. In many cases, new employees take one or more years for their employers to earn back what they are paid. With a layoff today probably costing future profits well into next year, it is likely a well thought out decision.

 

I consider all of these to be bright people and consequently advocate building up trading reserves. However, I also recommend maintaining significant permanent equity positions, as I could be wrong.    

 

 

 

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

Mike Lipper's Blog: What Moves the Stock Market? - Weekly Blog # 824

Mike Lipper's Blog: Picking Winners/Avoiding Losers - Weekly Blog # 823

Mike Lipper's Blog: Is This “Bull Market” Real? - Weekly Blog # 822

 

 

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 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Primer on Starts of Cyclical & Stagflation - Weekly Blog # 771

Mike Lipper’s Monday Morning Musings

Primer on Starts of Cyclical & Stagflation

 

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

 

 

 

Looking at the current US stock market, the determination of the next important market call is not known, at least not by me. On one side the believers think the Fed can change inflation by controlling the interest rates. On the other side there are pragmatists who see a much more complex world where stock and other prices can fall meaningfully for an indefinite period.

 

Recognizing that I like everyone else am a gambler, I look at how to prepare investors for either extreme. As usual, I find an imbalance born from a “liberal arts” education and the short form media. We have been conditioned to find an easily understood important trend demonstrating future growth. Because of its relative rarity, there is little knowledge concerning the downside of recessions/depressions and stagnation. Unlike the happy talk of growth, most people don’t want to focus on periods where people get hurt financially and emotionally.

 

Without predicting a significant move to the downside, I am gambling our time by examining the nature of possible material downsides. There is significant but not conclusive evidence that such a period is coming. If such a period does not come soon, at least you will have learned what to watch for in the future.

 

Troubling Signals

As with many laundry-lists, the order of observation is accidental and not meant to signify rank of importance or order of future troubles.

•  Continued short-term US Treasury rate inversion.

The 2-year rate is 4.51% which for many is attractive. This is quite competitive with stocks yielding less with uncertain futures.

 

•  Stock prices fell for 4 days last week.

• Excluding energy earnings, other companies lost -7.1% in ’22.

Are we beginning stagflation starting with 2016?

 

• $2.2 billion going into international equity ETFs vs. $1.7 billion going into domestic ETFs.

 

• Reasons for poor earnings from a successful importer: 

High and expensive customer inventory leading to low replacement sales and dollar weakness. There appears to be a switch in strategy from profit focus to cash management.

 

• OPEC+ did not raise prices when Russia cut production.

Quite possibly they felt that Biden was inflationary, which could reduce demand.

 

• China’s Belt and Road Initiative is slowing and shifting.

Need more US imports to pay for China’s exports.

 

• S&P Global is not issuing guidance, as the future is uncertain.

 

• A number of financial services companies are changing CEOs or making material changes, like Goldman Sachs.

One of our concerns is that most organizations are currently led by people with political skills, not operating skills.

 

• 31.6% of net ETF equity flows are in Chinese investments.

 

• Liquidity is declining again.

 

• WSJ article headline “Retailers Hesitate to Accept More Inventory” from apparel makers.

 

• Global Minimum taxes are inflationary.

 

• Wonder if the 60/40 ratio of stocks to bonds is misapplied.

Should it instead be applied to risk and less risk, with less risk defined in terms of income?

 

What is the Future?

While the gambler is forced to deal with possible changes to the present, the speculator accepts the present as the base case to build her/his model of preferred change. I am a combination of both, and don’t like the present or its logical path. With that in mind I suggest the following radical changes, any of which might change our current trajectory to a better future.

 

Possible, but Unlikely Changes

Recognize current economic problems are not a function of too little demand, but of too little supply. Demand in the commercial world for the most part is a function of competition and customer desires. However, in far too many transactions the heavy hand of government dictates what the customer will buy and at what price. It would be an interesting exercise to calculate how much government interference costs the economy!! My guess, it’s of the same order of magnitude as the cost to consumers of raising interest rates to somewhat ineffectively bring down inflation. (Inflation is caused by demand exceeding supply and excessive government grants.)

 

There are two other ways the government can reduce its costs and improve its services:

1. In an electronic age there is precious little advantage in having major government departments and agencies located in D.C. for the ease of lobbyists and the enshrinement of the government working class.
2. Government at the Federal and State/local levels are monopolists. The existence of Chartered Schools largely demonstrates that the school system can benefit from competition. I wonder whether the same could be said for hospitals and other medical institutions.

 

All organized spending groups, whether for profit, non-profit, or government agencies, could benefit from post spending analysis. We would then be able to see what was accomplished from the spending and what lessons could be learned. The more efficient companies, particularly serial acquirers, do this.

 

A similar approach would make sense in terms of aids and grants. This should be a requirement in regular reports to donors and citizens. I suspect the delivery costs are greater than the benefits.

 

Productivity measures have been in secular decline for many years. This is probably caused by inefficiencies in our society rather than labor’s bargaining power.

 

What are the inefficiencies you see?

 

 

 

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

Mike Lipper's Blog: Words that Trap: Growth, Value, Recession - Weekly Blog # 770

Mike Lipper's Blog: What will the Future Bring? - Weekly Blog # 769

Mike Lipper's Blog: Confession: Numbers Don’t Tell All - Weekly Blog # 768

 

 

 

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 – 2023

Michael Lipper, CFA

 

All rights reserved.

 

Contact author for limited redistribution permission.

Bear Market, Recessions, Reinvestment - Weekly Blog # 765

 

Mike Lipper’s Monday Morning Musings

Bear Market, Recessions, Reinvestment

 

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

 

 

H A P P Y  N E W  Y E A R  to  All

 

 

 

An Explanation

For the very first time since publishing these blogs we suspended publication during Christmas week. While most blogs suspend publication in observations of the holidays, we normally don’t. The reason being something could impact our subscribers’ investments every day.

 

Although we mainly focus on long-term investing, each long-term investment journey starts with a first step. Thus, we scan weekly market activity in search of possible initial steps. Transaction volume during Christmas week was low and quite balanced between investors believing we are close to a change in direction and those seeing deeper problems that will take longer to solve. Thus, a relatively flat quiet market did not send signals to me.

 

This week I was faced with almost identical low volume fog. However, I noticed there was more selling than buying on the three main US markets for the week. I recalled that most non-trader investors spend their time waiting, while perhaps also worrying. With those thoughts in mind, this week’s blog is about the critical stages of long-term investing in search of future rewards: Bear Markets, Recessions, and Reinvestment.

 

People have been grappling with these issues since the beginning of recorded time. Since I was not producing a blog this week, I began reading “The Price of Time, The Real Story of Interest”. The story begins with a portion of an inscription found on an Assyrian tablet from approximately 2800 B.C. One of the first written attempts to predict the future states “…the end of the world is evidently approaching.” Therefore, take my views and those of others with a grain of salt.

 

As all life appears to be cyclical, it is appropriate to start the first blog of 2023 with a look at the cyclical behavior of bear markets, recessions, and reinvestment.

 

The commonly used term for a bear market is a 20% loss from a former high. In prior bear markets I have lost 20% of my worth, but I have not lost my source of income (paying job) or main source of cash. During 2022 we certainly experienced a bear market, but luckily not for the full year. The mistake I made in writing my blogs was trying to get ahead of the crowd by labeling what we went through as the early stage of a recession. It neither qualified as an economic recession nor was I out of work, a popular definition.

 

My problem as both a portfolio manager and blog producer is the timing of labeling a recession, as it officially gets labeled a recession long after it begins. The pending label is useful in timing and making investment decisions. However, in waiting for the “official” label, remember that stock and commodity markets generally discount the future.

 

The three types of recessions are cyclical, secular, and structural. Most recessions include elements of each type, with one dominating. The most common type is a cyclical recession, which is generally limited to a price decline from the prior bull market high. The common perception by most investors and apparently the Federal Reserve is that we are likely entering a small and short cyclical recession. (Applying my contrarian nature from the racetrack, I am doubtful that the next recession will be that simple. Historically, if I am wrong, the penalty won’t be very large.)

 

A possible hunting list for stocks might be those that performed well for many years prior to 2022 and significantly declined this past year: Apple, Microsoft, Alphabet, Nvidia, Costco, Danaher, NextEra, Adobe, UPS, Texas Instruments, SalesForce, and S&P Global. All of these stocks have suffered from pricing, delivery, and other short-term problems. These issues also appear to be fixable and seem cyclical in nature. I or our accounts own some of these issues.

 

The second most common type of recession is a secular recession, which is caused by changing elements in the foundation of society. This type of recession generally has a lasting impact on the economy. Think in terms of women working outside of the home after WWII and expanding the number of people working, changing the size of homes and gross income.

 

We may be entering a period where a large portion of the population are not qualified or prepared to work in the traditional payroll structure. The most significant change could be the US, UK, Canada, EU, and Japan failing to reproduce at a sustainable population rate. Another problematic change is US students ranking in the middle to lower range on global tests below the college level. Quantitatively and qualitatively, there is concern regarding our future leadership.

 

As we move to succeeding generations, the society and economy may adjust to these “abnormalities”. Thus, they would be considered secular changes and hopefully not structural changes.

 

I suspect these types of changes cause long-term institutions to modify their portfolios. This may be the reason the State Street Investor Confidence Index decreased to 75.9 from 90.3 in the fourth quarter. Of interest are the different global readings: North America 72.2, Asia 86.9, and Europe 102.6.

 

The third and most uncommon form of recession is caused by structural change, where the way people think about earning money changes and never goes back. Typically, these changes are driven by technologies like the steam engine, the automobile, semiconductors, or by basic changes in government, such as divorce and inheritance laws.

 

The problem I have in questioning the type of recession relates to its likely frequency and financial impact. Which in terms of severity, from most to least, are cyclical, secular, and structural. However, in terms of significance to family wealth, the order is in reverse.

 

If one believes there is an all-knowing power in the sky wanting to eventually adjust the way humans operate, it might be by using economic cycles to correct for the way we screw up our lives. Economics is the historic tool that forces us to do the right thing.

 

There are multiple imbalances in almost every sector of our society and its messenger is the economy. There is hardly any part of society today whose leadership possess superior political skills, not operational, or judgmental abilities. Since we seem unable to solve these problems ourselves, we are going to be nudged in “the right direction” by a secular or structural recession. Corrective actions won’t likely come from a short or mild recession, as that would be like putting a Band-Aid on a gunshot wound.

 

While I clearly don’t know, I am on watch and ready to adapt the right moves to protect my responsibilities.

 

 

 

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

Mike Lipper's Blog: Week in Conflict Leads to Buy List - Weekly blog # 764

 

Mike Lipper's Blog: What does your 4.0 Profile Tell You? - Weekly Blog # 763

 

Mike Lipper's Blog: Week Divided: Believers vs Investors - Weekly Blog # 762

 

 

 

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 – 2022

Michael Lipper, CFA

 

All rights reserved.

Contact author for limited redistribution permission.

We are Progressing - Weekly Blog # 721

 

Mike Lipper’s Monday Morning Musings

We are Progressing

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

                  

This is a blog on investing and is not intended to express any political views. Every single action we take, including taking no action, is an action. Every single action we take has less of a future impact for those we care for emotionally or legally, be they the next moment, day, week, month, year, or the rest of our lives. With that thought in mind, my focus is on the indefinite time periods for those we hold ourselves responsible.

This blog is focused on an investment period measured in years, comprising multiple market cycles. In sharing my thoughts, I am very conscious that humility is the only guarantee in investing. There will be periods of elation and depression as we travel through the various phases of market cycles.

Point of Departure

I believe markets move within their own cycles. I find it useful to measure from peak to trough for the styles of investing which identify most of what we do. In the absence of detailed knowledge concerning the structure of an investment account, I use three major stock indices for the US equity market. The NASDAQ Composite Index, which topped out last November, contains future oriented securities valued for their growth potential. The S&P 500 Index, which peaked on the 4th of January, is meant to contain the 500 largest and most liquid US stocks traded in the US. The S&P 500 Index is representative of the bulk of long-term US stock investments and is often used by institutions to represent “the market’. The Dow Jones Industrial Average (DJIA), which topped out on the first day of 2022, is a selection of the 30 most representative stocks.

Where Are We?

As a working assumption I believe most US equities have topped out for this phase. What phase we have entered is the question investors are asking. The choices are:

• A minor fall to a support level like the Dow Jones Transportation Index, a key component of the oldest market timing model, the Dow Theory. 
• The NASDAQ Composite Index, which fell beyond the 10% correction level used by the press.
• The S&P 500 Index, which is close to entering a correction phase, to be followed by the DJIA.

As we manage long-term money, which has long-term payout needs measured in lifetimes, I believe we have entered a downward slope with periodic upward trading opportunities. (57% of NYSE stocks and 61% of NASDAQ stocks fell last week.) Hardest hit were growth funds, with the T. Rowe Price Growth Fund falling -4.38%, the worst of the 25 largest growth funds. 

Focus

Instead of focusing on trading opportunities, I am focused on the likely investment opportunities in the subsequent rise in the market after the valley. To get to the happy hunting ground we will have to deal with expected problems. In time order: Ukraine, inflation, and Long COVID.

Ukraine

As is usually the case, the media and politicians are focused on the wrong things. First, the Russian Army has a significant number of conscripts due to return to civilian life who are not battle trained. They would suffer significant casualties, which would not go down well within Russia. If the Russians invade, they are likely to suffer casualties caused by a well-armed and trained army and volunteers. They have a lot to fight for, as shown below:

• The Largest proven recoverable Uranium resources in Europe
• 2nd largest explored Manganese ore reserves in the world
• 3rd largest exporter of iron ore
• 4th largest array of natural gas pipelines
• 8th largest number of installed nuclear plants

To an important degree, Putin has already accomplished his goal of weakening NATO by showing the unwillingness of Germany to take up arms, followed by Italy and a weak US response. So far, the only negative from Putin’s point of view is the push by Sweden’s second largest political party to join NATO.

Inflation

From the White House’s viewpoint, it is pleased the market is doing the job that the Fed was meant to do. The markets most sensitive to short-term inflation are the commodities markets, which are pricing commodities higher in the near-term than the longer-term. Members of Congress are preventing the White House from adding to the problem, by resisting an increase in money supply growth. 

A study of 19 recorded pandemics over 700 years shows real interest rates falling in all cases. However, a complete solution to the supply chain issues has several hurdles to overcome and is unlikely to be solved before the next Presidential election. These include: 

• A shrinking number of petroleum refineries, from 301 in 1982 to 124 today.
• The absence of new mineral production and severely restricted new mine and pipeline volumes.
• Fewer skilled workers and supervisors returning to the workplace due to Long-COVID. 

Long COVID

Long COVID is the inability of some workers to return to the workforce due to PASC symptoms, which stands for Post-Acute Sequalae of SARS COVID. (Cumberland Advisory has a good blog on their panel discussion on the subject.) One study predicts between 10 and 20% of those who get COVID will get the Long version. One must expect other pandemics in the future, and we have not yet come to an understanding the best way to reduce their damage.

Investment Shopping List

While it may be a long-time before a terminal bottom is hit, and more importantly recognized, one should start building a shopping list. There are two categories that appear to be worth examining: common denominators and the not yet dead that are still working.

Common Denominators

At times it is difficult to pick a potential winner out of a crowded sector. I have followed two approaches on this issue. 

1. The first is to find a sound sector manager or fund to make individual choices. The problem is that manager’s need to diversify, resulting in too many choices. The second is to find one or two stocks that capture most of the future expected benefits. Two common denominator stocks in the financial services industry are Moody’s and S&P Global (already owned). Internal developments and acquisitions should capture additional business. These are to be put on the hunting list and should not be bought today, they are already more than adequately priced.
2. The second approach is to look at the non-winners in the current market to see if the sick/dying corpses have elements that will blossom in a new market. I use the multiple of current price to sales as a primary initial filter. Four large companies that could have something to value, in order of their price/sales ratios, are: 

Corning (2.55x)

Intel (2.49x)

IBM (2.15x)

HP Enterprise (0.78x)

HP Inc (0.64x)

I am sure that there are others, and they should be researched.

Subscribers: Please share your thoughts and suggestions. We unfortunately will have some time before we select new holdings   to new heights. However, it takes a lot of time to get to know new names and get comfortable with them, after what may be an unhappy period. 

  

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

https://mikelipper.blogspot.com/2022/02/building-long-term-investment.html

https://mikelipper.blogspot.com/2022/02/changing-focus-in-changing-world-weekly.html

https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.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 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Are Investors Taking Too Much Investment Risk? - Weekly Blog # 713

 

Mike Lipper’s Monday Morning Musings

Are Investors Taking Too Much Investment Risk?

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

One can rarely earn investment gains without taking investment risks. Investors often believe they imperil too much for the risk assumed. This view has led Lee Cooperman to comment that he is a fully invested bear. (He is counting on his timing and trading skills to save his capital) I am in a somewhat similar position in my investment account, which excludes my “burn-rate” and personal future generation endowment accounts.

Focusing on my operating investment accounts I wonder if I am taking too much near-term investment risk, as I do not believe I have sufficient trading skills and expect to be premature. The best way for me to escape a major decline might be to reduce the premature gap from “the top”. The way to do that is to recognize the excessive investment performance achieved by others as a precursor to a massive decline. Prior road trips with a young family echo in my mind, “are we there yet?”.

Listed below are an increasing number of signs of excessive investment performance:

1. Most diversified equity mutual funds produced a 20% gain for 2021, with some professionally managed investment accounts producing returns of 30% or better. History suggests that this is unusual and characteristic of an approaching top.
2. The types of stocks generating above average momentum are like those we have seen in the mid to late stages of a bull market. While stock market cycles and economic cycles don’t have to be coincident, the major ones usually are.
3. The pandemic’s economic cycle impact is unknown. In a normal investment cycle, it would either be the equivalent of an investment “bear market”, or as they say at “the track”, an aberration that should be disregarded. There is reason to disregard the impact of the pandemic, but market leadership does not look like the beginning of a new “bull market”. If we are not in a new bull market, we are in an aging expansion approaching ten years. Bull markets are not closely tied to an economic cycle, but there is something of an echo effect.
4. For some time, the predictive power of reported earnings per share has deteriorated, due to changes in accounting and regulatory rules. From a long-term investment perspective, I prefer to focus on aggregate pretax operating net income, which is not marred by non-operating net interest earnings and changes in share counts. I further attempt to back out the impact of changes in accounting rules, including recognition of depreciation and amortization.
5. We have entered a period of accelerating inflation, which needs to be considered when attempting to predict earnings power generation. This is particularly important in companies reporting significantly larger rises in net income than sales. There are many reasons for this, including operating leverage, with most of the gains coming from the exercise of pricing power to offset inflation. Earnings so generated, are not usually the source of future earnings gains.
6. There are lots of good investment managers, but some with “hot performance numbers” appear to have unsound analytical backing and may be generating gains from skilled market analysis. This is difficult to maintain and is what we used to call “racing luck”.

I am not attempting to precisely predict the future. What I am attempting to do as a good pilot is avoid air pockets that can cause a sudden drop in altitude or permanent loss of capital. 

After The Fall

To the best of my knowledge there has never been an active market that did not have intermittent declines. I therefore have a high level of confidence that at some point there will be future declines in all markets I’m invested in. 

There are two causes for wars, underlying and immediate. Analysts are unlikely to identify immediate causes beforehand but should be able to spot many of the underlying causes. Most of the causes are essentially an ongoing change in the perceived level of competition. When enough power has shifts to one side, the situation is fraught with danger. The leader sees an opportunity to further increase its power and the loser fears further loss of power. Either side may choose to react to this growing disequilibrium. I suggest the growing gap in relative safety measures are such that it is reasonable to fear some unplanned explosions.

 Whatever happens, it is our responsibility as fiduciaries to invest before, during, and after the fall. This plays to our preferred method of investing in stocks, which is through portfolios of mutual funds, mostly somewhat diversified. In preparation for this task, I read the diverse views of successful fund managers. The goal is to build focused portfolio of funds that think differently. This holiday week I had more time than usual to read what managers were thinking about the longer-term future. Two long-term very successful managers produced reports that should earn their place in equity fund portfolios, as described below:

The Capital Group published a 2022 Outlook on the “Long-term perspective on markets and economies”, which had the following highlights:

1. Market leadership is currently the same as it was before the pandemic. (This is an indication of a continuing long bull market)
2. Global economic growth is slowing, particularly in China. (Valuations have expanded, particularly under the influence of buybacks and M&A activity.)
3. Inflation should persist longer than expected, due to broken supply chains, shortages of materials, and more importantly of competent employees, particularly at the trained supervisory level.) Nevertheless, Capital believes inflation will not rise to the double-digit levels of the 1970s. In most inflationary periods stock and bond prices rose.
4. A good time to focus on stock selection by looking for pricing power, sustainable growth, and rising dividends.
5. Expect increased volatility in this midterm election year. (Perhaps this view is best expressed in the firm’s Growth Fund of America, ranked 17th of top 25 mutual funds year to date and the single best for the week ended December 23rd, gaining +3.55% vs +1.25% for the Vanguard 500 index fund. (Compared to many other growth funds, this multimanager vehicle is more risk aware.)

The other fund management group that has produced thoughtful pieces is the London based Marathon Asset Management. They are a successful global investor with a sizable sub-advisor and separate account business in the US. What distinguishes their thinking is their focus on the supply side of the equation, whereas almost all the other investment managers first focus on the changing levels of demand for a company’s products and services. This tends to put them earlier in the timing of the investment cycle. Their portfolios tend to look like those of a value investor, making Marathon a good investment diversifier in an otherwise growth-oriented portfolio. The following are some of their investment ideas:

1. Moody’s and S&P Global are viewed as an oligopoly taking fees for assessing credit instruments. (This is not completely accurate as there are a number of smaller credit tracking agencies, both in the US and elsewhere. What makes them attractive businesses is their ability to access a small increase in prices each year, as well as a fluctuating demand level. (At least I hope so, as both are in accounts I manage, and in a somewhat similar position is Fair Isaac, which provides FICO credit ratings on 99% of US credit securitizations.)
2. With a limited number of new copper mines coming on stream and local governments pushing tax collections, the price of copper is rising. It will probably rise much further as auto production moves to battery electric vehicles (BEV) from internal combustion engines. BEVs, which use roughly 80 lbs. vs 20 lbs. of copper per vehicle.
3. “Private equity will face major headwinds in a governance play with little leverage as topping” (This is another set of headwinds as it is an overcrowded area, with entry prices expected to rise and provisions expected to decline.) “Growth valuations are based on visibility, the ability to push out time horizons ten or twenty years into the future with sufficient certainty to justify paying for that outcome, a very difficult call in a new world based on political whims.”
4. Japan has not adopted the US approach to corporate governance and has limited M&A activity and corporate raids. Stock options are evolving, with more shareholder friendly conditions. (A number of global investors, including Lazard, have a long-term favorable view of Japan, despite its recent economic record. Japan is becoming a more needed US ally, both militarily and economically.)

Next week I hope to devote the blog to some things I and other investors have learned (or relearned) in 2021. Please send me an email on what should be included in the list.    

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

https://mikelipper.blogspot.com/2021/12/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/12/selections-weekly-blog-710.html

https://mikelipper.blogspot.com/2021/11/investors-be-alert-to-novembers-risk.html Mike Lipper's Blog: 

Request to subscribers

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 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.