Mike Lipper’s Monday Morning Musings
Changing Focus in a Changing World
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
Changing Focus
Securities analysts should come with two perspectives. The majority attempt to read the current minutiae of what companies are saying, with the goal of assessing the current price and the probability of relatively short-term future prices. The second perspective, rarely produced for public or client consumption, eventually pays bigger rewards when correct.
For some time, this blog has highlighted the relatively unreported negatives concerning the current optimistic outlook. Entering 2022, there are more comments about risks and possible recessions, which while still in the minority of published opinion, has increased in coverage. At this point there are enough bearish comments, so I can move on to the much tougher challenge of finding reasons to be optimistic. The eventual major stock and bond market decline is inevitable, although I cannot identify the time and headlines that will label the decline. Furthermore, I cannot stipulate the length of the bear market, which is normally a function of what owners do, not what issuers do. In other words, from the current lofty levels I am beginning to look across the valley of disappointment to the beginnings of the next expansion.
I look forward to learning the views of subscribers, both concerning the down phase and the recovery.
Changing Environment
The future will contain a multitude of changes, many small, but a few unexpected by most will verge on being seismic. At some point in many developed countries, the growing size of government debt owed to non-citizens will be too large. Not only will foreigners refuse to buy more, but they are also likely to push for debt repayment, not rollovers.
For many Central banks and commercial financial institutions, US debt is a prized asset. However, Mae West may finally be wrong in that “too much of a good thing is wonderful”. In 1990 the Federal Debt totaled $3 Trillion, now in under half of a lifetime it is $30 trillion. Politicians of both parties are responsible for this growth in our children’s and grandchildren’s debt. Interestingly, 35 of 50 states require balanced state budgets. (One can examine the financial health of the 15 states that don’t have this restriction, comparing local crime and inflation.) While the growing debt is deplorable, it is probably a good indicator of how the government meets its other responsibilities. (Some houses never have a single broken window.)
Looking at the implication of the growing debt and its likely impact on the investment environment in 30 years. The debt will impact our children’s assets and the future value of what our grandchildren inherit. It would be prudent to expect taxes of all sorts to increase. Increased taxes will lower the reported earnings of companies and will probably delay the dividend increases the third generation may be living on. Will it likely lead to lower price/earnings ratios? (Since the 1950s we have generally benefited from rising earnings multiples.)
There are at least two other changes to our investment environment, both positive if one’s portfolio is properly positioned. The first is that winning companies and institutions, no matter what they do, will make progress by improving customer service. Because technology will likely continue to lower the costs to manufacture and transport, the winners will have the attitude of successful service companies.
We are already seeing the third trend that is going global. Year-to-date figures show the US market declining more than 5%, while Brazil is up +10%, Greece +8.5%, South Africa +6%, and Chile +6%. Five other countries have positive equity markets. We are also seeing positive fund flows into Western Europe, Japan, and Emerging Markets. This is probably not a short-term phenomenon. While one can understand a certain reluctance to disclose critical information in patent applications, the number of patents granted suggests a large amount of technology innovation is taking place outside the US. The percentages of patents awarded in 2021 was: China 49, Japan 15, South Korea 11, US 10, and Europe 8.
Changing Companies
Many companies continually evolve, some more dramatically than others. As my primary focus is financial companies, I see some making changes that should impact earnings patterns in the future. Goldman Sachs (*) is developing a retail banking base to fund their investment banking activities. It is my speculation that when Buffett and Munger are no longer involved with Berkshire Hathaway (*), shareholders will own more than one stock certificate. Over time it is reasonable to assume a number of their activities could generate higher stock prices if separated. I also suspect that if the Fed, FDIC, and Treasury come under more restrictive management, a number of banks will split their activities requiring a bank license, placing the more profitable businesses in another company. Watch JP Morgan Chase (*) for such a move within ten years. The financial sector may initiate dramatic changes in how they manage their human relations and work from home activities.
(*) Owned in managed accounts or personal accounts.
Changing Investors
The current effort of some governments to regulate an increasing amount of corporate activity through regulatory bodies will drive more investment into private companies. There is already some level of private market transactions, which will increase. NASDAQ (*) has been active in this, as have a number of brokerage firms and banks. This drive may well lead to more cross border transactions. In dealing with private companies, valuations are often based on verifiable sales data, which includes a price/sales comparison. There is a lot of room for such transactions. For example, the P/S ratio for the Russell 1000 Growth is 5.12X, with the MSCI World ex US Small Cap being 1.05X.
In terms of investment sophistication, there are private investors capable of protecting themselves as smaller institutional investors. There are times where not being public is better for both the company and its investors. In many cases these investors have entered a second career as a supervisor or confidant to multi-generational family assets.
Question: In your thinking about the future, what changes are you expecting and how will you handle them?
Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2022/01/things-are-seldom-what-they-seem-weekly.html
https://mikelipper.blogspot.com/2022/01/two-critical-questions-weekly-blog-717.html
https://mikelipper.blogspot.com/2022/01/current-causes-of-concern-weekly-blog.html
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A. Michael Lipper, CFA
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