“New Normal” Unlikely to be a Repeat - Weekly Blog # 635

Mike Lipper’s Monday Morning Musings

“New Normal” Unlikely to be a Repeat

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

Analysts love history, believing the future will be a repeat of the past. Almost every force for change today is itself changing. There is so much changing that there is a great temptation to retreat to cash or a central value index. Quite probably, the least realistic and useful diagram for the future is a straight line. However, there are a series of mathematical manipulations that may be useful in identifying the multiple “New Normals” we will go through.

I believe it was in the second year of algebra that we were introduced to simultaneous equations. In these equations each formula has a different unknown, requiring each to be solved before completing the entire equation. There were other useful exercises that could also be helpful in our search for an investment strategy. The first, which was mislabeled as geometry rather than logic, was proving theorems. In that exercise we segregated math formulas between those that supported the theorem and those that did not. The correct solutions were based on the logic displayed, not the number of pros and cons. Perhaps the most useful math we learned was the math dealing with circles and semi-circles. I believe that learning to think in circular patterns is much more representative of the reality of human (market) behavior.

Where We Are is More Important Than How Far We’ve Traveled
Utilizing the two-sided balance sheet approach, I will divide the current inputs between those I perceive as positive for long term investing in equities and stock funds vs. those that increase the risks of losing money.

Positives
In analyzing data we look for indicators that on balance successfully predict the future. Positive indicators are normally correct more than half the time. However, what is even more valuable are the rare negative indicators. On a contrarian basis they are correct more than 75% of the time.

1. One of the best negative indicators is the sample survey of the American Association of Individual Investors (AAII). In the latest week, for the second week in a row, the survey is increasingly bearish, 48.9% and 47.8% respectively. A more normal three-part distribution has numbers in the thirties, as it was three weeks ago when it was 38.1%. Rarely do the weekly readings go over 40% and it is extremely rare for any choice to exceed 50% for the six-month outlook. 
2. Private clients at a large US brokerage firm bought equities for the first time in eleven weeks.
3. Individual investors are not constantly wrong, although they tend to make up their minds slowly and consequently tend to be wrong at turning points. (Data is no longer corrected on transactions below 100 shares, so we can no longer use the odd-lot theory.) If we look at total flows, we see net purchases of $11.3 billion for fixed income securities and funds, including $2.6 billion going into TIPS and $5 billion net outflows from Equity. These flows are forcing the prices of fixed income products up and their yields down. This reflects market action and is not a predictor of future interest rates.
4. We appear to be in two different markets at the same time. The daily stock price chart for the NASDAQ Composite is in an uptrend and has been establishing new highs. The other two main market index price charts look to be forming a temporary top, despite 24% of the S&P 500 being invested in FAANG stocks plus Microsoft. In 2013 the same stocks represented 9% of the index.
5. Rising freight volume carried in trucks is expanding, leading to capacity expansion.

Negatives

1. The Citigroup Panic/Euphoria Model is predicting a bearish period one year away.
2. Investors are pouring money into fixed income, even though there is a long-term expectation for higher interest rates driven by inflation. One example of this is a repeated issue of a 100-year bond from Austria, a country without a particularly bullish outlook. A pitch used to sell very long bonds is that it avoids having to make more frequent decisions, which can be wrong!!!
3. Some US investors are investing outside the US or the dollar. Of the 25 best performing mutual funds this week, 16 were precious metals funds (gold), 3 were emerging markets funds, 2 were China Region funds, 2 were India funds, and only 2 were invested in domestic small caps. Except for the precious metals group, the individual holdings in the other 9 funds appear more important that a sector bet.
4. The VIX indicator of worry is selling at twice last year’s rate.
5. Friday’s volume rose, which is not normal in the summer months, revealing interesting results that need to be further examined. The stock of T. Rowe Price lost 7.62% for the week, even though it published good results. On Friday, Janus Henderson had a market volume of 10.66 million shares, where the normal volume is 1-2 million shares.

Conclusions

1. We should not expect some clear straight-line news any time soon. That is not to say various pundits will not extoll these points of view, but on careful examination the precision of their views will come into question.
2. Despite what various political leaders state, we live in an increasingly integrated world and that is a net good thing, although it has a price, among other difficulties.
3. At today’s prices we are being paid to take long-term equity risk and are not being compensated similarly for fixed income risk taking.
4. We should focus on the announcement of capital expenditures in order to see how much is being invested in new products and new distribution, or see if it is being used to lower existing costs.

What Do You Think?   

 

Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/06/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/06/data-driven-reactions-dangerous-weekly.html

https://mikelipper.blogspot.com/2020/06/caltech-data-heretics-go-to-track-for.html



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Time to Get out of the “Foxhole”? - Weekly Blog # 623

Mike Lipper’s Monday Morning Musings

Time to Get out of the “Foxhole”?

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

Quite possibly the biggest mistake in the world is not recognizing that some critical fundamentals are changing. This mistake rests on strongly held views of the future, that it will seamlessly extrapolate from the immediate past or quickly be governed by a new order that will make sense of it all. Good luck to all who believe this.

I start from the assertion that I don’t know what the future holds, either for us or our investment responsibilities. Nevertheless, we know that we cannot stay still in our present condition. Now is the time to recognize that there have been some small changes in the last two weeks that could be meaningful. They have already rewarded some double-digit returns.

In the weekly ranking of traded price changes, a minority of 24% are going up. Not surprisingly, the biggest gains were for those related to oil, which had a relief rally of 25%. However, several unrelated prices also rose somewhat. (Consumer Staples +3.46%, Copper +1.63%, TIPS +0.90%, 7-10 Year US Treasuries +0.79%, Gold +0.54%, +20 Year Treasuries +0.48%, and the Yuan +0.06%). I find the rise of both copper and the yuan hopefully significant. The commodity market players and economists often refer to copper as “Dr Copper”, because it is often an indicator of early demand. The minuscule rise in the Chinese yuan is another indicator that some things in China are improving.

Fixed Income Quandaries 
All too often people group investments with a specified maturity and expected interest rate into the same category, such as government bonds and other bonds with a high credit rating. This can be quite misleading, as evidenced in this week’s Barron’s. The Best Credit Bond Yield average dropped by 37 basis points, while the yield on intermediate credits rose by four basis points. (Remember, bond prices go in opposite direction of yields). The market was therefore pricing the safety of credit more than it was higher yield.

I was at a meeting recently where a money manager included the high yield portion of the portfolio with other bonds. I suggested that high yield paper normally travels parallel to stocks, not bonds, and he agreed.  With interest rates currently at historic lows, high quality bonds should not be counted on for income. They should be recognized as a source of capital to be reinvested into bonds at higher rates (lower prices). This is particularly true now as the yields on longer maturities are rising. (One of the reasons that retail investors with high yield mutual funds underperform total returns is that they spend the distributions rather than electing to reinvest them.) Many disagree with my view in last week’s blog that rising deficits around the world will drive inflation and interest rates higher, and in time a lot higher.

Market Structure Changes
There is some inconclusive evidence the US stock market has hit a bottom. Market analysts suggest that some time must pass for the market to establish a large base before a successful assault on prior record levels can be made. One reason this makes some sense to me is that recessions are meant to correct the excesses of a prior bull market. Perhaps the reason the previous long expansion did not go higher was too many old zombie companies not earning their cost of capital. If this was the case, the next expansion will likely be shorter.

There is plenty of “dry powder” that could fuel a big expansion. One metric Wall Street focuses on are the portfolios of individual investors and for years they looked to Merrill Lynch to provide this view. This now comes from Merrill’s new owner, the Bank of America. They have indicated that the amount of cash in their client’s accounts are at a ten-year high, with the amount in bonds at a seven-year high. Additionally, the large amount of uncommitted funds in private equity is blocking them from raising new funds. The recent market decline has brought the S&P 500 ratio of market price to book value to below 3 times, a level at which M&A deals are often considered.

Covid-19
The public, media, and politicians are looking forward to the “flattening of the curve”.  This may be occurring in Italy, Spain, and New York state in terms of death, not number of new cases. Much more important to me are the vast majority of those who died in both Italy and China having other medical problems. What I don’t know is what killed them, the virus and its complications or their other problems. The following table, provided by US authorities, lists the proportion of patients that had other medical conditions:

Chronic Renal Disease     74.8%
Cardiovascular Disease    61.0%
Diabetes                  54.7%
Former Smoker             49.4%
Immunocompromised         42.4%
Chronic Lung Disease      40.4%
No Underlying Condition    9.7%

Perhaps a positive spin on this tragedy is that it is causing us to rethink, not only our healthcare systems and personal relationships, but also the structures of business and educational organizations.

Hylton and I wish you and your love ones good health. We hope you are practicing good procedures to protect yourself, your loved ones, and the people you are in contact with. We will get through this together.

Question: From where we are today, how should we organize to make us all better?



Did you miss my past few blogs? Click one of the links below to read.
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

https://mikelipper.blogspot.com/2020/03/searching-for-bottom-understanding-and.html



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Searching for and Suffering Great Funds - Weekly Blog # 545

Mike Lipper’s Monday Morning Musings

Searching for and Suffering Great Funds

Tied to Columbus Day Image Control

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

My Perspective
Commercially for the most part, I manage mutual fund only long-term accounts for both institutions and wealthy individuals. In general, I and my associate Hylton Phillips-Page attempt to construct equity portfolios that contain Good Funds and Great Funds. The dividing line between the two is the long-term fear and greed ratio. In some cases this can be translated into the tolerance for embarrassment. To paraphrase what Warren Buffett has said, he would prefer an investment whose path is an uneven compound growth of 12 % over a more even 10%.

Our Three Bucket Tasks
Exercising experience, judgement, and a lot of performance and portfolio data, we divide the fund universe into three buckets.

• The first bucket are possible candidates for the great fund managers, which is a small group. 

• The second bucket are the good funds that most of the time produce satisfactory results. 

• The third and largest bucket are the other funds, which should be studied to identify characteristics to be avoided. These observations require long records to be reviewed and entail visits to managers, their staff, competitors, and clients.

Numbers Filters
Analyze the fund’s record under the same portfolio manager, pretty much the same staff, senior management, and the same investment and commercial goals. Some minor adjustments can be made, but if there are too many we need to begin the analysis at the point where these inputs are reasonably stable. Thus, a stable universe is created.

The next step is to compare the manager’s relative quarterly performance quintile among the appropriate peer group over 40 quarters. A good manager’s performance will be in the mid quintile and the next highest performance quintile between 24 and 30 times during the 40 quarters. In the remaining quarters the preponderance of the quarters should favor the top quintile over the bottom quintile.

Great managers will spend most of their time in the best quintile. However, the second most likely placement will be in the bottom quintile. Those quarters need to be examined carefully. Great managers are often out of phase with the current market and give up current market opportunity for capital preservation. Thus, the worst quintile performance is often a small absolute gain or loss. Large losses need special explanation. It would help if a bad quarter is followed by a top quintile performance.

The Human Filter
Investments are an art form based on a mix of personalities operating at the same time. Too often investors treat the short hand of numbers as reality. The interaction of the various personalities throughout the ecosystem of the fund drives the results. In discussions with the various participants, total intellectual honesty should not be expected. I have learned to group responses into categories in order to build a more complete picture from the various fragments. The following is an example of this approach:

Good Fund Managers limit their cash to 5-10% of assets and are politically sensitive in their organizations to clients. They try to avoid excess volatility and are often top-down thinkers, motivated by the long-term prospects of promotion translated into money.

Great Managers will use cash as a residual, primarily when they can’t find attractive holdings. Thus, cash holdings in extreme cases could rise to 50%. They are very individualistic in many of the things they do. They will occupy the best and worst quintiles more frequently than the more controlled good managers. Great managers are very bottoms-up and are detail oriented in their thinking. Their preferred time-period is a lifetime, but they will sell when disappointed. These are “rare ducks” who are quite introspective and may not provide the best interviews. Rarely will they enter crowded stocks and are contrarian by nature. They are hard-working and would probably fit in with the current Chinese work effort of 12-hour days, six days a week. When focused, they are good observers of people and consumer trends. They feel deeply when they make mistakes and try to learn from them, even though they often repeat the same types of mistakes. When they are early into a stock they can hold the position for a long period of time. These can produce what Peter Lynch called “ten baggers”, or gains of ten times or more the original investment.

Image Control/ Columbus Day Perspective
Most successful professional investors are by nature private people and don’t like to discuss their current investment thinking. Several r of them overcome their shyness, driven by commercial needs, to bring new money under their management. Often, others have the responsibility to use the successful investor’s record and skills to make them both rich. One of the fears of the successful manager is that the public relations machine will exaggerate the investor’s accomplishment.

Monday in the US we have a national holiday, Columbus Day, to celebrate the popular view of his discovery of America. In truth, he never landed on the North American continent. Prior to his voyage, at least two other explorers landed here. Nevertheless, there are aspects of his life that some of the Great Managers have paralleled in their own careers. These are:

1. A man of great conviction [right in concept and wrong in details]
2. Could not raise the money for the exploration at home and went abroad to Spain.
3. Leveraged the Queens’ jewels to get the needed cash.
4. Diversified risks by having three ships, tow returned.
5. Lost control of the theme upon completion of his successful voyage.
6. His discovery was an excuse for US politicians to grant an important urban political group of union workers a national holiday. No similar holiday exists in either Spain or Italy.

Thus, an investor’s success becomes a commercial vehicle for the greater success of others.

Where to Hunt?
As every single day is a day to think about the search for great managers, what does last week possibly signal?

1. For the week, six of the seven biggest market performance leaders tracked commodities. 
2. Five of the seven worst performers were stock indices.
3. While most funds declined, there were some winners that gained more than 1% for the week - Base Metals Funds, Agricultural Commodity Funds, Precious Metals (Gold) Funds, Natural Resources and Energy Funds. DOES THIS MEAN THAT THE MARKET IS MORE CONCERNED ABOUT INFLATION THAN GROWTH?
4. Longer-term targets of future opportunity: Longevity Care and Management, Food allocations, Disruptions to come from AI/VR, TIPS.

Conclusions:

• The world is changing in both identifiable and unidentifiable ways.

• Good equity managers perform credibly well most of the time.

• The rare great managers will find ways to make a lot of money, but it won’t be a comfortable ride unless one builds that likelihood into ones’ expectations.

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Price Trends, Clues and Concerns - Weekly Blog # 506

Introduction

Bonds, stocks, and commodity prices are sending different clues while the pundits proclaim synthesized global economic growth. After thirty-six years of rising returns for fixed income, almost a decade of stock market gains, and commodity prices entering a new cycle, thoughtful market participants are confused. The one common impetus is growing confidence in decision-making. With more confidence investors are consciously or not accepting more risk because they are getting a somewhat clearer view of the future. As a contrarian, and often allergic to popular views, I have my doubts. I am not totally alone. Ian Bremmer of the Eurasia Group has said, “2018 feels ripe for a big unexpected crisis." My concern is that the growing confidence is crowding out a reserve for surprises, good or bad.

Inverted Yield Curve Fear

While it is true that the last seven fixed income prices declines came after the 2-10 year US Treasury yield curve inverted, I do not believe it is an immutable law of investment science. Nevertheless, it is a proper place for study. There is a similar pattern in the futures market when near-term investments are more expensive (higher yield) than long-term ones. What is important is that the market view is that the near-term future has more risk than the longer-term. Often this is right, but not always. Remember the surprise factor. In my opinion an inverted yield curve if and when it happens is more descriptive of current fears than predictive of long-term prices. Fixed income prices are set by supply and demand and are similar to the odds posted by book makers which are not the result of careful analysis but prices that will bring new bets into balance to keep the bookmakers’ capital risk into reasonable balance. The bookies and the bond market will lose out only if there are too many surprises.

The fears that there are oncoming inverted yield curves or other causes for bond prices to decline have been operating for the last few years. The biggest concern is not credit losses, but inflation. To service those who are concerned that inflation will rise above current levels, the US Treasury and others have created TIPS (Treasury Inflation Protected Securities) funds which are issued in roughly the same maturities as the other treasury paper. For more than the last three years the total return investment performance of the average TIPS fund is slightly better than the average intermediate US Government Securities fund. For longer periods the reverse is true. One wonders what the relative performance results would be when the reported inflation rate finally reaches or exceeds the Fed desired 2% level. It is possible that our and others are from time to time paying premiums to buy inflation protection and this is why the TIPS funds perform better rather than their pricing mechanism?

If one is managing retirement capital accounts for those that are currently working, I would substitute 30 year treasury yield for the 10 year. (More on this later.) 

Individuals investing in fixed income securities or funds should separate the total return numbers between income (interest) payments and market prices. Inflation will not nominally impact the income stream, but may have significant impacts on both the prices of the bonds and the purchasing power of the proceeds.

At Caltech and other places studying how the brain makes decisions, they have found that most humans make decisions on finding past memories that coincide with current conditions. Every now and then, the occasional winner will see the current situations as sufficiently different than the past that they opt for a new strategy. In other words the preferred algorithms will give way to new thinking and actions.

Stocks Are a Confidence Game

Almost every prognostication from brokers, advisors, and commentators in terms of the stock market were expansive. Two recent examples display the enthusiasm for the stock market are as follows:

Extrapolating the first full trading week suggests that the S&P500 will triple this year.

Goldman Sachs believes that the Bull market should run for another 3 years.

“Investors Intelligence” tracks letter writers in its latest report in Barron’s; 64.4% are bullish and only 13.5% are bearish. In approximately the same period the AAII weekly survey showed a significant reversal in their volatile report with the bulls declining to 48.7% from the prior week’s 59.8% and more significantly the bears gained to 25.1% from 15.8% the prior week. The AAII sample shifts each week which could have caused the changes and this week some were more worried about the impact of the bond market or were reaching to political news.

Commodities are Active

Based on perceived increasing demand from China and rising demand from US manufacturers, industrial metal prices are rising. In a classic example of a surprise, the price of oil touched $70 a barrel this week and there is a press story that some expect the price to reach $80 this year. In response, over the last four weeks the best performing mutual fund investment average is the Natural Resources funds, up 12.66%. As a contrarian and a long-term investor I am wondering when the increasing population and shrinking farming land will be seen in rising prices for grains. This hasn’t happened in a long time.

Very Long-Term Outlook

The latest available estimate of the global retirement savings gap in 2015 was $70 trillion and by 2050 it is estimated to be $400 trillion. Thus, in only 35 years there is a need for over five times more capital to be invested for retirement. (This is why I suggested using the 30 year yield for the spread calculation.) How should one invest to meet this long-term need? I do not believe that today one can evolve a consistent investment policy to meet these needs. My contrarian nature suggests that it may be easier to identify what not to do. The average S&P500 mutual fund beat 90 out 96 mutual fund investment averages for the last five years and 84 for the last ten years. I don’t think that will continue. The best performing hedge funds in 2017 were invested in large caps and securities driven by momentum (FAANG + 2 from China).  Different strategies at different times will be needed to avoid losses and achieve gains. This is why I believe that a portfolio of different funds or managers is the most prudent for the long-term.

Question of the week: What are the most prudent strategies for the long term?

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Cyclical and Secular Concerns Vary with Time Horizons - Weekly Blog # 490

Introduction

“Horses for Course” is a racing expression which indicates that horses run differently at different racetracks. Not only different courses but different lengths of race. As is often the case, what is true in the analysis (or handicapping) at the track is also true in the selection of managers, securities, and investment strategies. These concepts were the genesis of my developing different timespans to be used for managing investment portfolios.

In the first two timespans, Operating and Replenishment, significant financial losses are difficult to overcome and thus cyclical considerations dominate. The longer term Endowment and Legacy portfolios assume periodic declines, but that long-term secular trends will dictate their future performance.

As we appear to be entering a period of switching gears from complacency or frozen in place, to one of growing enthusiasm, the prudent investor should increasingly wonder what could go wrong. Of the myriad of possible future events it is unlikely that one can accurately predict what will happen. At the current time I feel an obligation to point out possible unanticipated problems.

I will first focus on possible cyclical problems that can impact investment performance through an intermediary period of roughly five years and thus cyclical factors. In the second part of today’s blog I will focus on Asian, African, and Latin American factors that could impact the longer term secular trends.

Cyclical Factors for the Intermediate Term

As Professor Robert Shiller points out, almost everyone acknowledges that a recession will happen. He further states at the moment that not too many investors are concerned about a future recession. The popular securities indices are regularly reporting new high levels. However, the best performing of the three indices, Dow Jones Industrial Average (DJIA), Standard & Poor’s 500 (S&P500) and the NASDAQ Composite (NASDAQ) is the last one by a considerable margin, as small companies particularly those involved with information technology including Apple^* performed well. While the NASDAQ is slightly reporting new highs, it is not demonstrating a major breakout after hitting a new high and thus it may be questioning the strength of the move. This is not particularly upsetting because as in the past, Apple shares sell off after new product announcement run ups. As a long-term owner of these shares I am much more focused to see the level of sales and deliveries in its fiscal second quarter ending in March 2018. While some market rotation is healthy if it does not include a strong NASDAQ performance, it would be demonstrating the “animal spirits” are getting tired.

^*Held personally

Market leadership rotation is normal and expected, but when one or more of five sectors or asset classes lead, it will be an indication that investors are deserting the central forces of the economy. If you possess trading skills the five sectors could be very productive. If you are like the most of us who move in and out late, be very careful. The five in alphabetical order are Bonds, Commodities, Energy, Gold, and TIPS. If you are an accomplished player, play. If not it would be time to build reserves, particularly if you are managing a current or replenishment account.

As mentioned last week the gains in earnings being reported for the first half of 2017 are due to expanding profit margins. Earnings per share are growing faster than revenues which are growing slowly and in some cases very slowly in the second quarter. To create sustainable earnings and employment we need to see revenue generation pick up.

The potential expansion in the level of enthusiasm for stocks may be heralded by the decline in neutral sentiment in the latest AAII survey, dropping from 36.7% last week to 32.7% this week, and a roughly similar increase in bearish attitudes. This suggests to me we can see an important increase in volume which in and itself engenders more volatility.

My real concern for the intermediate future centers around the bond market which is larger than the stock market but can be much more sensitive to short-term events. I don’t know what can create a bond market bear market, but the following are thoughts that needs to be understood:

·       The little understood bank for central banks, the Bank for International Settlements, has noted that many governments, including the US, are only identifying contingent liabilities in their financial statements. These include unfounded pension and medical costs. One potential concern of mine is a large size of unprofitable investments by China in building its One Belt One Road Initiative (OBORI) in neighboring and other Asian countries.

·       Yields on high grade corporate bonds are rising which means prices are falling slightly, showing some lack of demand. At the same time yields on lesser quality bonds are holding up, showing an increase in demand.

·       Just as yields go in the opposite direction, the contrarian in me suggests that flows follow performance late and stay too long. In almost every country that has a mutual fund business there is an increase of substantial size in the flow into bonds. They are easy to sell to people in view of the low manipulated rates dictated by central banks that impact commercial banks’ deposit rates. This excessive flow is augmented by the large number of financial groups offering new credit funds without sufficient experience in non-bank lending.

In sum, I grow increasingly wary in crowded markets.

For the intermediate term investor I see more performance/career risk than we have seen in sometime. Perhaps, we will escape but by the next US Presidential Election the odds are that we are going to be tested.

Secular Concerns for Longer Term Investing

For only long-term investors to consider in their third (Endowment Timespan) and their fourth (Legacy Timespan) portfolios are some surprising inputs from a two day visit to Mumbai, India. To fulfill two speaking engagements at a very busy time of year, my wife and I flew into Mumbai Thursday night and left on a redeye Saturday night. The purpose of the two speeches was to have discussions with Indian mutual fund CEOs, portfolio managers, independent investment advisors and distributors of funds. There are forty fund houses with thirty four reporting their net asset value in the paper. I made the point that they have only penetrated 3% of the households where in the US the penetration is over 40%. In addition to focusing on mutual funds, I had hoped to find some good long-term investments for our family accounts. I knew it to be a long shot in that the Indian stock market for the year to date is the best performing large country market. I was impressed with the quality of the Indian professionals that inhabit their market and compete with a relatively small number of foreign funds that are devoted to investing in India.

As with many adventures and experiments, there are surprises generating from some disappointments in the initial objectives. On Saturdays there are two major financial newspapers published in India, (The Economic Times and Financial Express) which have articles of interest that could impact future investing in India, China, Africa, Latin America and other Emerging Markets.

The following are briefs from the points of views expressed without any additional research or separate opinion from this traveler:

“Africa Sees India as Key Growth Partner” is the title to an article that contrasts with the way India is viewed as compared with China as a source of development spending. According to the article "Recent media reports have carried allegations that Chinese business houses are treating African workers as slaves...." India on the other hand is viewed as a collaborator with the locals. The article mentions an Indian-Japan-Asia-African Growth corridor as an alternative to China's One Belt One-Road Initiative (OBORI). Apparently the Chinese focus is natural resource development for export principally to China. The Indian-Japanese-Asian effort focuses on rural development and agriculture, energy, and  education. In addition they are interested in quality of life issues and within the region, connectivity. This is similar to the development practices that are found also in Latin America. (India itself is beginning a campaign to improve the lot of its farmers through the application of technology along with capital.)

The Indian Post Payments Bank next year expects to equip a large portion of its postmen with equipment including biometric readers, a debit and credit card reader, plus a printer. Thus home dwellers will be able to quickly and safely pay various bills.

"Chinese Government Plays Cupid to Help Youth Get Married" is an article about 100 million young people in China that are not married. The government is sponsoring a blind date service. It specifically suggests that marriage will aid in future development.

SBI Life this week had an IPO and produced two interesting details, for this the largest life insurer in India. The first is the offering was oversubscribed by a 3.58 times ratio led by institutional buyers. What was of interest to me is that High Net Worth Investors only utilized 70% of the allocation available to them and retail investors used just 85%.  From my standpoint the most interesting numbers were that in 2016 the Indian Life Insurance industry penetration was 2.7% and this compares with 7.4% for Korea, 5.5%  in Singapore, and 3.7% in Thailand.

Can you imagine what more I could discover if I spent another week, month, or years in India? Seriously, my very brief visit highlighted to me that investors should not isolate the impact of single nations in making decisions. China, India, Africa, and Latin America as well as the rest of the Emerging Counties are linked in many ways that need to be understood for successful long term investing. 

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The Fallacy of Investment Certainties

Premise

In the worlds of politics, economics, and investing there are no real certainties. By definition a certainty is guaranteed to happen. The guaranty makes it inevitable now and in the various, undefined, futures. We are not equipped to define all the possible futures. Events as presented, particularly unpredicted events, shape reactions often differently than expected.

Introduction

I am incredibly lucky as to the people and situations that I have been exposed to over many years. Perhaps, the other side of that lucky coin is rarely can I be exposed to someone or an event that my mind does not search for an investment meaning. My two great educational experiences, the US Marine Corps and the racetrack have shaped a good bit of my thoughts. The Marines have taught me how very ordinary men and women can do extraordinary things with the proper leadership and training. Further, the USMC taught me that the single best defense is an offense, which tends to drive my impatience into action. The racetrack where I really learned the process of analyzing people and events introduced the concept of the odds of comparing potential payoffs versus a range of probabilities. Out of these analytical exposures I became aware of weighting my bets and the elements of diversification.

I am reaching my investment conclusions by analyzing this week's inputs and my investment reactions.

This Week's Inputs

Discussions with fellow Caltech board members, faculty, and senior staff separately focused on how unnerved they were about the future for its lack of certainty in terms the impacts of changes in political and government grants. My reaction was first “Do not confuse votes in favor of a candidate with votes against another one or policy.” On both sides of the Atlantic and the English Channel people were fundamentally voting against the past. These wise people in Pasadena were very much worried as to what the future would bring to Caltech and to the Jet Propulsion Laboratory that it manages. Caltech staff also had many personal concerns. 

While they were worried, I could empathize with them; however I was not sympathetic. I have always grown up in an uncertain world - if you really looked at it carefully. To me it always comes down to understanding the odds on various future results with a keen awareness that events often override plans. When I mention odds I am not looking for mathematical precision but views arrayed in probabilities which at best could be divided into quintiles. Further, I am totally convinced that if some very unfortunate low probabilities occur that the secondary reaction of all these bright people would change some of the negative impact. Further, to some degree for those who choose to survive there is always a Second Act or next race.

I already mentioned how lucky I am by being exposed to a large number of people, many of whom are bright and accomplished if not both. This week a respected good friend sent to me a very small book entitled "The Usefulness of Useless Knowledge" by Abraham Flexner with a companion essay by Robbert Dijkgraaf. Flexner was the founding director of the Institute for Advanced Study at Princeton and Dijkgraaf is its current director. Flexner’s essay was first published in Harper’s in 1939 . In a period of increased applied research, the book is a plea for basic research. I thought the essay was particularly telling and could provide some comfort for my friends at Caltech. Some of the highlights from the book are as follows:

• 30% of US GNP is based on inventions

•  More than half of all economic growth comes from innovation. Einstein said "Imagination is more important than knowledge, but added, "Knowledge is limited and imagination is not."

• Richard Feynman said "Scientific creativity is imagination in a straitjacket."

(Both Einstein and Feynman did some of their best work at Caltech.)

Inputs from Other Reading During the Week

New products, processes, and systems create new solutions to old and new problems and thus create new and different jobs.

There is a new way to measure the industrial growth in China by measuring the night time lights. (This is interesting in that this can be a commercial venture because of the suspicion as to the quality of the government released data. Of course that wouldn't be an issue here in the US! Also this is not dissimilar to the old analyst's technique of measuring a business by counting cars in a movie studio or industrial plant.)

Europeans seem to be more savings-oriented including their use of Money Market funds whereas in the US there is a more investment orientation including the use of Inflation Protected Securities funds (TIPS). Few seem not to share my long-term concern that materially higher inflation will be a concern.

Moody's* view is that credit conditions will improve due to M&A activity. (This is the reverse of historic experience, as M&A activity led to over-leveraged balance sheets which led to some bankruptcies.)

^*Held in the private financial services fund I manage

Daily stock price gaps are most often filled before prices move very far. For the first time in my limited memory in all three US stock price indices (DJIA, S&P500 and NASDAQ) there are recent two price gaps in each.

My Investment Reactions

First the beauty of the TIMESPAN L Portfolio^® approach is that it helps to separate one's thoughts about current actions by likely impacts in future timespans.

1.  Our overweight in the Legacy Portfolio (our longest term portfolio) in disruptive growth remains in place. However, growth is not exclusively technology-oriented. Demographic and political changes can be equally disruptive opportunities globally.

2.  Endowment Portfolios need to be keenly aware of any changes to the range of spending needs and have enough portfolio flexibility to accommodate possible radical changes and opportunities. 

3.  Replenishment Portfolios need to watch likely swings from excessive enthusiasm and fears as we negotiate the next markets on the way to a recession. 

4.  Operational Portfolios should be concerned with interest rate reversal patterns to ensure that it can fund short-term expenditure plans.

Bottom line: as long as there is little enthusiasm, the odds seem to me to range relatively small on the downside (less than 25% ) and materially higher blow-off of 100% or higher.

Questions to Ponder: What are the likely ranges for your portfolios for the next five and fifteen years? 

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A. Michael Lipper, CFA

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