The Week’s Fashions and Our Most Dangerous Asset - Weekly Blog # 643

 

Mike Lipper’s Monday Morning Musings

The Week’s Fashions and Our Most Dangerous Asset

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

There are instances where very current observations can have long-term implications. The week that ended last Thursday night was quite possibly such an instance. Each week I examine a report on the performance of over one hundred different investment objective peer groups. Since the competitive game, not the investment game, is beating “the market”, I look at what types of funds that have beaten the S&P 500 Index Funds average performance. In the quiet lazy summer week, the index gained +0.40%. The following is a list of the seventeen peer groups that beat the index:

Base Metals Commodities   +2.83%

Precious Metals           +2.43%          

Energy Fund Commodities   +2.11%         

Large-Cap Growth          +1.83%         

Science & Technology      +1.60%         

Global Science & Tech     +1.58%          

Multi-Cap Growth          +1.52%         

Convertible Securities    +1.37%        

Consumer Services         +1.25% 

General Commodities       +1.13%

Agricultural Commodities  +0.78%

China Region              +0.77%

Global Large-Cap Growth   +0.77%

Global Multi-Cap Growth   +0.70%

India Region              +0.61%

Alt. Active Extension     +0.49%

Telecommunications        +0.45%

Most of these leading groups have been leading for some time, benefitting from momentum. The commodity owning funds look forward to higher prices for them and inflation for their customers resulting from shortages of supply.

One could say that these groups were deemed attractive by some pundits and their followers. Thus, if one would invest in most of these, the bet is not on the fundamentals of the underlying companies and commodities, but on the expected pronouncements of various pundits. To me, this suggests that these funds are likely to be more volatile than most funds. Thus, they make sense for those who believe in their trading skills or have a firmly held view of the investment cycles of the future.

CASH Is the Most Dangerous Asset in the Portfolio

Cash is a dangerous asset, not because it may lose some value, but because of how we exit from it. Remember, almost without exception every single loser we have had started from exiting cash. Potentially, the biggest problem in having cash is the way we think about it, our portfolio, and ourselves.

Whether we have a thousand, ten thousand, one hundred thousand, a million, ten million, one hundred million, one billion, or ten billion, as we jump each successive hurdle it gives to us a different attitude about ourselves, our status among others, and the safety of our situation. However, these emotional and intellectual highs can be very misleading. 

Cash is a receipt from past activities and its value changes imperceptivity every day due to the interaction of currency and inflation. Additionally, changes in tax regulation and investment/legal practices change the purchasing power of cash. Another critical element impacting how we feel about cash and other attributes of wealth is the perceived wealth of others, either foolishly published or gossiped. (The wealthy lists are not adjusted for present debts or future commitments. Some multi-millionaires have assets tied up and have little or no “walking around money”.)

The expected use of cash defines the flexibility of wealth. Large families in terms of number or generation of people need to think about the state of their physical, emotional, and mental health when considering future spending. Only some family members and their highly trusted advisors have a real understanding of the extent of cash and other indications of wealth. Often, no one has a complete picture of the emotions attached to assets/liabilities and how that influences their disposition.

Working Toward Solution Suggestions

The best suggestion I have is to adopt a holding company philosophy like Berkshire Hathaway, which is a holding of some clients and held in personal accounts. With over 60 operating entities and over 100 separate financial centers, their current operations retain enough of their cashflows to meet current needs and send the excess to headquarters for future investments.

The first suggestion deals with the proper identification of reserves to meet specific needs. It can include specific elements such as buying future residential property, education expenses, specific medical needs, and a loss of employment reserves. Determining the size of the specific reserve will at best be guesswork, but some numbers are better than none. A much more difficult task is guessing the range of future dates when the reserves will be tapped. It is at this point that an intelligent allocation of cash and risk/return assets should be made. The closer the likely expenditures, the higher the allocation of cash or extremely high-quality short-term paper. However, there are risks associated with funding long term needs with short-term paper and cash. My own view would be the following reverse ladder:

• 100% cash for assets to be spent in the next 90 days
• 80% cash for assets to be spent one year in the future
• 60% cash for assets to be spent two years in the future 
• 50% and no higher in cash beyond that 

My second suggestion is to divide one’s portfolio into two separate parts, the reserve element just mentioned and an investment portfolio with at least a ten-year view, potentially extending beyond multiple generations.

The investment portfolio should avoid holding cash except for a tactical reserve, with a time lock forcing some commitment if the tactical reserve remains after 18 months. Remember the following things:

• In an investment portfolio cash is a decaying asset due to inflation and currency. 
• If you must reduce or eliminate cash, the investment opportunities are vast and include some relatively safe alternatives. 
• Long-term successful investors often go through periods where they are very lonely.     

 

Questions of the week: 

1. Do you monitor the opportunities to invest investment cash?
2. Do you review your reserves periodically to ensure that they are appropriate? 
3. What was the last time you adjusted your cash levels and what was the result? 

    

   

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

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/08/rotating-leadership-likely-on-horizon.html

https://mikelipper.blogspot.com/2020/08/more-to-learn-by-seeing-more-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.

Changing Investment Directions-Different Views - Weekly Blog # 642

 

Mike Lipper’s Monday Morning Musings

Changing Investment Directions-Different Views

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

August Calls

Market analysts have frequently identified August as a month of change in market direction. During a period of normally low volume, a little extra volume in the face of vacations can have a disproportionate impact. In addition, August usually firms up detailed plans for the highest grossing 4th quarter, while preliminary plans for the next calendar year are being finalized prior to final approval. (But we are not living under normal conditions. Thus, I believe it would be wise to adopt a “fan approach” to planning, with at least a high, low and middle ground, to prepare for the probability that there will be rapid changes that require action.)

Because of my professional life experience I start each analysis looking through the mutual fund industry data, which is often a useful clue to both markets and the broader economy. For the week that ended last Thursday night, “Value Funds” gained +2.25% on a weighted average basis. This compares with a tiny loss of -0.02% for the similarly weighted average for “Growth Funds”. Most often the investment trends that occur within the US market also occur in the international markets and this week it was true for both the international funds registered with the SEC and the “offshore” funds we track. Nine value funds were in the 25-best performing mutual funds for the week. Also on that list were five financial sector funds. Overall, financial sector funds gained +3.08%, with industrial sector funds doing slightly better +3.10%. The prior leading sector groupings declined, Science & Technology -1.56% and Global Science & Tech -1.45%. 

While a few weeks of performance does not guaranty a longer-term trend, all longer trends start with a few observations. The stock price moves of value vs. growth are way ahead of changes in the direction of earnings, although they are in parallel with many views expressed by politicians around the world.

China Pulling Ahead

Despite the rising level of tensions between the US and China, it appears on the surface that the trends within China are improving. One of the ways I follow what is happening in China is by reading the research provided by the fund management group, Matthews Asia. The following brief points were derived from their research.

• There were no COVID deaths in China in the first 12 days of August.
• Auto sales are improving on a broad scale in China, particularly for foreign brands. In July, Toyota increased +19.1 % (including Lexus +38.6%), Honda +19.1%, Nissan +11.6%. General Motors sold more cars in China than in the US.
• Last year, 60% of China’s GDP growth came from internal consumption, with only 17% of GDP being gross exports and only 17% of that going to the US. While the US and most of the rest of the world have problems with the policies and activities of the Chinese, we cannot realistically isolate them. We need to come to some accommodation with them for us all to grow.

The “Sage of Omaha” Throws Curves

Warren Buffett for many years threw out the first pitch for the local baseball team. In the second quarter of 2020 he threw a curve ball to investors with his second quarter transactions. Even if our clients or personal accounts did not own shares in Berkshire Hathaway, we would still study the company’s financials and/or pronouncements. I have suggested that a well-constructed financial and business graduate course could be conducted using only their documents. Their successes are legendary, but their few errors are even more valuable as teaching moments. Last week they published their 10-Q report and their second quarter publicly traded securities portfolio with the SEC. Each is worthy of detailed study.

The 10-Q reveals that the company should not be compared to either an open-end or closed-end fund, as it is intelligently leveraged with borrowed money in the form of debt and potential future payments, using customer float and future tax payments. Offsetting the leverage are large amounts of short-term US Treasury bills and other high-quality fixed income/cash holdings. The company is an investment portfolio of publicly traded and private equity holdings that utilize excess earnings for operational needs to buy new investments. It does not currently pay cash dividends, as shareholders benefit from the increase in value of their holdings. Recently, they have become a relatively small buyer of their own stock. Unlike many corporate CEOs and Portfolio Managers, Warren Buffett and Charlie Munger’s time horizon is that of their shareholders’ heirs. Thus, any large- scale disposal of assets comes as a surprise.

The publication of their report to the SEC of their publicly traded securities transactions in the second quarter was a surprise. In summary, they materially reduced their holdings in most bank stocks, although the report did not provide an explanation as to why. Earlier in the year they did provide an explanation as to why they sold out of all their airline stocks. They felt that it would be a period of years, not months, before air travel returned to 2019 levels. Without an explanation from “The Sage”, I am searching for one and have come up with two possibilities:

• The results for the first quarter were depressing and that got to him. (I use the singular, as the size and long-term holding period suggests that this was the curve ball pitcher himself making the primary decision.) Many felt that way, including a very long trail of the AAII weekly sample survey.
• While the political inclination of Mr. Buffett tends to lean toward the Democrats, he may have been worried about Berkshire’s huge position in the financial services sector. The thought that a specific senator from Massachusetts might be Treasury Secretary could well be scary. 

I have great respect for Warren Buffett and even more for Charlie Munger and have learned a lot from them. They have also enriched our clients and personal accounts. The only thing I promise to our accounts is that I will be wrong from time to time. Hopefully, I won’t take too long to recognize my mistake and correct it.  Nevertheless, I am not reducing our exposure to the financial sector at the moment, as with rare exception their stock prices do not reflect their earnings power in normal times. (A lesson I learned from the great John Neff.) I will admit that branches will have to be converted or closed. Quite possibly, lenders will be required to have equity in their borrowers, or similar socially driven radical changes. Governments and societies are unlikely to function successfully without a viable financial sector.

Question of the Week: What are your thoughts?

    

   

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

https://mikelipper.blogspot.com/2020/08/rotating-leadership-likely-on-horizon.html

https://mikelipper.blogspot.com/2020/08/more-to-learn-by-seeing-more-weekly.html

https://mikelipper.blogspot.com/2020/07/mike-lippers-monday-morning-musings.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.