Pre, Premature Wish - Weekly Blog # 780

 

Mike Lipper’s Monday Morning Musings

Pre, Premature Wish

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

 

 

 

Motivation

After stripping away all the worries, details, and paperwork, the critical mission for analysts and portfolio managers is optimizing the capital of our clients, including their families. Despite our perceived brilliance, it is much easier to accomplish this mission during a “bull market” rather than a “bear market”. The biggest mistake and most difficult to recover from is missing the beginnings of a significant bull market, which is very easy to do.

 

Most of the time markets travel through various transitional phases:

• Early recognition by a few far sighted, but often difficult people.
• Growing acceptance.
• Almost universal acceptance, except for the worrywarts.
• Finally, the proclamation of a permanent condition. 

As the inevitable bear market becomes visible the process is reversed.

As it is difficult and dangerous to jump aboard an accelerating train, I prefer to board when it is marshaled in the yard. The difficulty of getting aboard requires an amount of brains, courage, and luck. That is precisely what I am attempting to do by focusing on conditions before travel begins.

 

Pre-travel Conditions

First, study past bull market journeys. Some start, but relatively few amount too much. Why? It may be that the damage done by the prior bear market was insufficient to get the necessary support. Additionally, the market may lack reasonably competent management capable of selecting the right track and able to keep the momentum moving in the right direction at increasing speed. Enough momentum to break the friction caused by others, including one’s own partners.

To start a bull-market you must first have been sufficient pain from the preceding bear market, with the ability to initially fund dominance over key doubters.

Today, there do not appear to be sufficient losses needed to be made up. However, for most of this calendar year there have been more shares sold at lower prices than bought at higher prices, both on the “big board and the NASDAQ. Most trading weeks there are more shares sold at lower prices than at rising prices, by a ratio of 4 to one. Buyers are labeled as accumulators and sellers as distributors by market analysts. Contributing to distributions are some investors moving out of dollar-based securities. The US dollar is in its fourth decline in fifty years. With the proceeds from their sales many investors are buying bonds, either for the first time or in quantities way beyond their habit. Others are investing in European and Asian stocks.

Currently, the risk of losing a little in bonds and stocks is probably close to being equal.  As new fixed income buyers venture into higher risk paper, the potential exits for higher risk paper to generate greater loses in fixed income than for stocks.

The total global economy is slowing. Not only in sales, but also in profits as margins narrow due to government policies restricting profits. There is a tendency to lower perceived risks.

After an investor loses more than expected, there is often an emotional need to quickly recover those losses. This is the second wave of money that will be sucked into buying stocks in a new bull market, and so the cycle begins again.

As much as I want to participate in a new bull market, it is apparently premature. Consequently, we must husband our resources and work to find relative islands of improving profitability.    

 

Thoughts?

 

 

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Long-Term Investors, Mistakes Ahead - Weekly Blog # 624

Mike Lipper’s Monday Morning Musings

Long-Term Investors, Mistakes Ahead

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

We wish and hope that all of our readers and
their loved ones are in good health and none
suffer from Covid-19 and its aftermaths.

Investing is, or should be, a series of learning experiences. In the long-term, we apparently learn more from our mistakes than from our “successes”. One puzzling occurrence that I have noted are some individual and institutional investors making repeated mistakes that impact their long-term investment results. At critical points in time, instead of utilizing their usual contemplative decision making, they allow emotions to drive decisions. I believe we are approaching a juncture where a sizeable number of otherwise smart investors make investment decisions that significantly hurt their future long-term returns, if not reversed.

The Focal Point of Large, Sudden Recoveries
We hit a “stealth” bottom on March 18th, with a “test” on March 23rd, in the US and many other markets. (A test occurs below or higher than the first bottom, but critically does not lead to more selling and substantially lower prices.) Since these low points, some mutual funds have jumped by 40% or more. In just the last trading week, the 25-best performing mutual funds gained between +35% and 21.36%. Traditional investors could choose to ignore these results due to the performance leaders likely making successful extreme bets. Relative to the impact on the wealth of the total investor population, the performance of the 25 largest long-term funds is relevant. It’s also worth noting from a national economic standpoint that the performance of the middle of the road “Core” equity funds is especially important, as this is where the largest portion of individual and institutional money is invested. I believe it is significant that the best performing large mutual fund for the week was American Fund’s Washington Mutual Investors. It rose +10.03%, while the worst all large-cap equity funds, a global equity income fund, gained +4.98%. To put this perspective, annualizing the gain of +4.98% would surpass 250%, an impossibility. This demonstrates how unusual the week was.

Ok it is Unsustainable, Now What? = Mistakes
There are three mistakes people make when investment performance appears too good.

• An immediate attempt to lock-in an unsustainable gain, a smart decision if one is never to invest again. The first problem in selling at the presumed top is that it puts a high premium on making two correct investment decisions consecutively. The skill to recognize tops and bottoms are quite different. Recognizing the present situation while fathoming the future, or more correctly futures, is quite different. Remember, many investors believe the sole reason for the market decline in the February-March period was the Coronavirus, not our concern of a tactical and strategic slowdown in earnings power generation. (The odds on identifying future trends different from those extrapolated from the present is probably 50% to 65%, allowing for the occasional surprise.) 
• The nature of critical turning points is the second problem. Almost by definition a turning point is when the bulk of trading actively changes radically, an emotional change. To be in a position to timely anticipate the change you must believe you can accurately feel what the crowd is thinking and when it is changing. From a profit and loss standpoint, there is no difference between being premature and wrong.
• The third hurdle is the assumption that the investor completely knows of any changes in demand placed on the advisor of the capital in the investment account. As an investment advisor I have never been comfortable with such assertions by others, or myself. We live in an uncertain world.

Another group of investors that has a substantial proportion of their wealth uninvested is driven by “FOMO” (Fear Of Missing Out). They want to quickly make up for lost time and get invested in stocks that are moving up. Their answer is to jump on whatever is moving most. This is called momentum. The problem with this choice is that after the original investors’ needs are met, as the only thing driving these stocks higher are other momentum players who may quickly move on to other investments.

To avoid these problems, if you find yourself with excess capital after filling all your essential reserve requirements, I suggest you divide the excess capital into perhaps ten segments, then invest a segment on each down day, which often fall on Fridays. For those more long-term oriented who have obligations to others, I suggest with bias that they consider a portfolio of mutual funds, allowing professionals to make tactical decisions.

A Contrarian’s Dilemma
Almost all investment courses take the easy way out by statistically analyzing financial statements and past economic conditions. The reality is the value of a stock is comprised of two very different aspects. While the first is taught, the second relies on the attitudes of those with buying power. This in turn is impacted by the buyers urgency to buy and the present owner’s urgency to sell. Price is where the two forces meet, with the next price a function of the size of the commitment of both sides at current prices. If the competing buyers have more money, the sellers will benefit from a higher price. If the seller demonstrates a larger desire to offload his/her merchandise, the intelligent buyer will get a temporary bargain. This equilibrium price is not only recorded in the regulatory records, but is also remembered by the participants and those who analyze their actions, e.g. market or technical analysts who don’t have the benefit of the specific motivations behind the trade. When there are a significant number of price changes in one direction, a trend is identified. No trend goes on forever and eventually reverses. A successful contrarian attempts to capitalize on trends that reverse direction. Historically, the trend best expected to reverse is the one trumpeted by many “experts”, or other pundits. Most of them currently anticipate further single digit gains following those generated since mid to late March. With the preponderance of investors sharing that view, I as a contrarian (long-shot better) am wondering whether we are setting up for a period of double-digit future gains?

This is where market analysis might foretell the future, without knowing the motivation of future buyers and sellers. Because of my background in analyzing mutual funds and similar vehicles, I often turn to their performance data for clues. For the last five years through Thursday’s close the three largest categories by current assets have produced very sub-par compounded returns: US Diversified Equity +3.83%, Domestic Long-Term Fixed Income +2.09 %, and World Equity +0.24%. None of these averages meet actuarial requirements or satisfy planned endowment expenditures. This suggests that many pension and probably other retirement funds, including endowments, are underfunded, potentially requiring larger future contributions and lower reported earnings, or in the case of endowments less ambitious plans. They could also be bailed out by a significant period of gains over 20%. (It used to be that gains over 20% were excluded in actuarial calculations.)

As someone who must meet payroll and other business and family expenses, I cannot completely live in the world of market analysis or contrarianism. Thus dear reader, please send me a message of what will motivate buyers of securities enough to raise returns to high single digit levels, with an occasional low double-digit gain year and only minor declines. I need help!!

Long Shot
As is often the case, the solution could come from beyond the present universe where we have the vast bulk of our assets. Perhaps there will be a reversal in the value of the safe-haven dollar, without medical and demographic plagues interfering with them. Emerging markets, with particular emphasis on Asia and later Africa, are currently an unpopular area. Both could make sense for our younger grandchildren, or more likely great grandchildren, but it won’t meet retirement needs or the needs for better educational diversity and other worthwhile goals.

Question: How are you addressing your investments today in order to meet longer-term needs? 



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/04/time-to-get-out-of-foxhole-weekly-blog.html

https://mikelipper.blogspot.com/2020/03/where-we-are-depends-on-where-we-have.html

https://mikelipper.blogspot.com/2020/03/stealth-bottom-and-other-considerations.html



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A. Michael Lipper, CFA

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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.