Haven’t Found Bottom Yet! Investments & Military Win by Committing Reserves Successfully - Weekly Blog # 732

 

                                

Mike Lipper’s Monday Morning Musings

 

Haven’t Found Bottom Yet!

Investments & Military Win by

Committing Reserves Successfully

 

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

Investment Success Defined 

Avoiding losses and participating in “bull markets” is the objective of my blog. To accomplish this goal, one needs to expect some losses. However, the key is to not lose too much capital, so gains are multiplied. The strategy I use builds up reserves when the prices of what my clients and I own are high compared to perceived general market risks. I allow capital reserves to build up to the point of meeting conservative cash expenditure expectations, plus a trading reserve for future investment. Years ago, insurance companies set up “valuation reserves” to capture gains above 20% to use for the next upswing. Inherent in this strategy is the assumption that there will be periodic down markets. The trick to making this a successful strategy is the proper timing and approach to committing reserves. 

 

Committing Reserves 

This is the single most difficult task, both for an investor and military leader. In each case the reserve can be wasted by committing too early, and that is why it is often committed piecemeal. For an investor it is important to identify a time and price soon before a price rise, whereas for the military it is near the point of exhaustion of the enemy’s supply chain. It is for this reason a market’s reaction to current events becomes much more important.

 

Why No Bottom Last Week 

 In theory, I should be calling a bottom for last week. We had a relief rally on Wednesday after the Fed publicly acknowledged inflation was more than transitory and committed to successfully addressing it. The next day, led by “growth stocks”, the market wiped out considerably more than the prior day’s gains, with further losses the final day of the week. 

Historically, the price level for the stock market occurs either before or after the high-volume day, when sellers feel compelled to liquidate at any price. We did not see this happen last week. I noticed at least three inputs that questions the longer-term outlook for stocks. 

 

“3 Strikes and You’re Out” 

This is what the baseball umpire yells when a batter misses the pitched ball three times. Perhaps that was the proper call for the week, with the three strikes against the Fed being their attempt to hit the inflation ball out of the park. However, they failed to see the very fast pitch delivered by the seasonally adjusted money supply. M2 grew 12.11% year-over-year, even after considering the current rate increase and three additional anticipated 50 basis point increases to 2.5%. This may be all the politically diseased Fed can do as it ignores the major cause of inflation, the stimulus (bribes) fed to the economy by the White House over the last two administrations. (I don’t know how much of the Russia-Ukraine war expenditures are in the current M2 numbers). 

Immediately following the rate rise, the major banks raised their prime rate to 4%. Remember, in theory the prime rate is reserved for the bank’s best credits and does not include much of a loss reserve. Currently, most banks are overflowing with deposits and a lack of good loans. Most commercial bank stock prices are also languishing based on their near-term outlook. If major banks require 4% on almost riskless loans, what should the investing and depositing public require from other financial institutions in the way of yield? This is the second strike against the market and the Fed. 

 The third and final strike is a curve ball ordered by the FTC and SEC. The regulatory mandates they extended way beyond prior policy practices.  If this expansion is permitted, public companies will expand less and many private companies will never be traded on US stock markets. 

To demonstrate how much the reach of these agencies has expanded. The newly appointed chair of the FTC recently announced she was examining the proposed takeover of Twitter by Elon Musk and a group of associates and lenders. The SEC simultaneously intends to examine the disclosures of ESG and compensation. (This could lead to transforming the current cyclical decline, from a bear market in progress to a secular recession/depression, following their FDR model.)  

 

A Bully Hits Someone Who is Down 

 Each week I view stock markets through the lens of mutual fund performance. Most of the time it is wise to pick an investment period that includes an up and down price market for analysis. This week I examined the latest fifty-two weeks, which includes both rising and falling markets. I found that there were only twenty categories that had positive returns out of 110 peer groups. The highest return was for the average commodity energy fund, which gained 97.33%. The smallest gain was 0.12% for dedicated short funds. The vast majority of the winners were asset heavy with a perceived marketable value. There were no intellectual property winners. Inflation is driving stock prices and the government is contributing to it, rather than addressing inflation, the biggest single tax on the financially disadvantaged. 

 

Question: Is your portfolio’s current value keeping up with inflation adjusted spending? 

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

https://mikelipper.blogspot.com/2022/05/three-worries-april-near-term-slowdown.html

https://mikelipper.blogspot.com/2022/04/short-long-term-thoughts-weekly-blog-729.html

https://mikelipper.blogspot.com/2022/04/is-this-great-investment-era-ending.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

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Next Rise Needed for Peak

Introduction

Last week's post hinted that this week I would discuss where are we on the track to a major peak, an issue that I have been concerned about for some time. History suggests that those who use a crystal ball to predict the future are often forced to eat crushed glass. I certainly doubt most people's ability to predict the future with any accuracy. I do not claim any special powers or intelligence. What I do believe is useful is to cogitate about what can happen in the future that is not a mere extrapolation of a current trend.

Fear of loss of opportunity

The way people write about the large losses suffered from major declines is wrong or at best incomplete. There are two missing pieces. The first is what families talk about in terms of foreclosed leveraged loans which transfers property; i.e., the family farm or business. For me the second loss (which is both more difficult to measure and much more important in the end) is the loss of opportunity to make very cheap purchases of property, businesses, and securities. Based on the past, purchases made in distressed periods have yielded capital appreciation of three to one hundred times original capital. Throughout recorded history, burnt investors, often hurt by intellectual or legal frauds swear “never again.” They won't believe in any positive view of the future. We are already seeing investors, particularly younger investors, pulling back.  With this so-called risk revulsion as a prospect, I am focused on a track to be wary of the next market peak.


Watch for these signs

A sharp, narrowly focused big rally that will dramatically change the individual participation in the market is almost a requirement for a generational peak. Peaks need to suck in all or almost all available capital. They do this on the basis that despite an immediate strong upsurge, that further large price gains are a certainty. We have not yet had this precursor, but we could be setting it up starting with this week.

After 205 trading days without as much as a 5% general correction, we did get one by early February. This last week saw a  relatively low volume rally that regained almost all of the decline. The gain in the week was impressive. Perhaps impressive enough for people to extrapolate that 2014 could produce the kinds of remarkable gains that 2013 did. (Our own private financial services fund, as did some others approximately, produced a 40% gross gain. We have warned our holders that this type of gain is not expected to be repeated again in the near future.)

Volatility and dispersion

How could we put up some spectacular numbers that would excite people to override their natural caution? The answer is in two technical market words, volatility and dispersion. The mathematical definition of volatility deals with the amount of price movement that is different than some trend line. The popular press tends to only refer to volatility on the downside. The kind of exciting upside market price movement that will need to occur to suck lots of money into the market will not be called volatility, but genius. What will cause this kind of movement? That will be dispersion. The market is moving away from the high correlation market that took almost all stock prices down five years ago. What is happening now is that the relatively little volume being transacted today is away from the large secure stocks even though one could make the case that large caps and their supposedly large liquidity is the safest place for institutional investors today who are conscious of the age of the current bull market run. We are seeing most of the volume being done in social media-related securities widely defined. (In some cases these are the re-birthed "TMT" names, technology, media and telecommunications.) Just contemplate that Apple^* has a market capitalization exceeding Exxon. Listen up at your next cocktail party when the conversation moves from "Bridgegate" to the stock market, count the number of times Apple, Google^*, Twitter, and Facebook  are brought up relative to Exxon. Then judge by looking  at the outer ring  around the conversation and guess what they will be buying and selling soon. One of the reasons individual stocks can skyrocket is an increasing number of insistent buyers are overwhelming the market with buy market orders not terribly concerned about their going-in price because the rewards will be so large.

This kind of action can, and to some degree is, happening in selected currency, commodity, and bond markets which are deemed to be professional arenas. These can be reinforcing a bullish stock market. Much has been written about the smaller than normal interest rate spread between high quality and high interest paying paper. One of the reasons Moody's^* went to a new high this week was the increase in high yield offerings expected in both the US and Europe, which will require credit ratings. And this is where the reinforcement to the equity market comes into the picture. Moody's recognizes that historically low expected default rates will make high yield (low quality) bonds more attractive for purchase. Whether these new bonds are part of a refinancing scheme that lowers interest rates and extends maturities or are totally new to the bond market, the mere successful offerings in the bond market tend to make the issuers’ stock price rise. (This kind of reaction has penalized high quality stock funds compared to those which invest in lower quality or marginal companies.)

^*Stocks owned by me personally, by the private financial services fund I manage, or both.

Haywire

Markets collapse not because of immediate economic conditions, but from rumors or news of unexpected occurrences; e.g., the assassination of the Archduke Franz Ferdinand that was the proximate cause of the beginning of World War I. Clearly I do not know what event will stampede the market decline after a meteoric rise. But I have a possible one to think about. The present Chinese dynasty is very conscious of collapses of prior dynasties; they also think in longer terms than most of the world's political leaders and even some far-sighted military leaders. China is building for periods way beyond  the current expected terms of office. They want to restore China's place in the world to be number one. Along the route a lot can go wrong unexpectedly. Some problem dealing with China in rumor or reality could be the equivalent of that relatively minor shot in the decaying days of the Austro-Hungarian Empire.

What are the sorts of unexpected things you think could cause some future collapse or you don't think there will ever again be a major collapse? Please let me know.

_____________________     

Did you miss Mike Lipper’s Blog last week?  Click here to read.

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A. Michael Lipper, C.F.A.,
All Rights Reserved.
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Mostly Positive Adjustments for Investors

Introduction

In last week’s post I mentioned one of the slogans used in the US Marine Corps, “Adapt, Improvise, and Overcome.” As today, November 10^th is the 238^th birthday of The Corps, I was thinking of all the adjustments it has had to make to become the nation’s premier fighting force. Though The Corps can handle almost any mission assigned to it, much of the slogan has to do with overcoming the rigidities imposed within itself and the US Defense establishment. I wonder whether Pope Francis is using a similar approach as he tries to adjust the behavior of the Roman Catholic Church, which could have impacts on many other organized religions.

Less cosmically, while painful in some cases, we are seeing a number of current adjustments that are subtly or perhaps not so subtly adjusting investment thinking as outlined below.

Lessons from the Twitter IPO

Twitter with the help of its lead underwriter Goldman Sachs^* had a successful launch of its IPO. While they did raise the price of the offering several times similar to Facebook, they did not adjust the number of shares being offered as Facebook did. The NYSE, the venue for the aftermarket, went through exacting trials under stressed conditions that NASDAQ^* did not with Facebook. The President could have learned a lot from the Twitter launch and adjusted his attempts to re-launch a somewhat more successful Obamacare.

A possible lesson to be feared

In a syndicated column by George F. Will entitled “The Enigma of Janet Yellen,”  the author  was concerned that by past experience and training, Ms. Yellen has been amenable to penalize savers to benefit equity owners around the world. He fears that in the absence of fiscal policy leadership, monetary policy led by the Fed is going to in effect, become the conscience of the government, and lead to adjusting our social priorities through the use of various monetary devices. If Mr. Will’s concerns are realized, the rate of inflation will rise and the dollar may shrink.

Unwinding of the 4% rule.

For many years’ wealth managers within or outside of trust departments have believed that a 4% withdrawal rate during retirement was possible without destroying the capital base. Today, based on the current low interest rates, some careful advisors are more comfortable with 3%, and T. Rowe Price^* believes 2.8% is more prudent. If these lower numbers are to be believed, spending and saving efforts will need to be adjusted. A similar exercise is needed for a number of endowment and foundation boards to contemplate.

Liberal Arts needs to be liberated

Currently a significant number of liberal arts colleges are facing declining enrollments, rising expenses and less than great returns on their too small endowments. Part of their problem is that often these organizations are governed with a high level of rigidity. Even in government, during periods of stress high-priced workers can be laid off. Granting tenure in higher education is often a one-way street, in that after being granted it, the tenured ones can stay employed as long as they want regardless of their productivity. 

One of the fields of study that should be examined by the payers of college tuitions is Macroeconomics. Robert Shiller, a 2013 Nobel laureate wrote a blog published by the Guardian entitled, “Is Economics a Science?”  He properly questions whether it is a science like Physics. He accurately says that the study of Economics has to do with policy. I suspect that is how this course is taught which could have some benefit to Political Science majors whose aim is the Presidency or slightly lower. On the other hand, Microeconomics introduces some techniques which could be useful to both consumers and producers. In my particular case the focus on price-setting with different degrees of inelastic supply and demand was useful in my business and investment career. What I am suggesting is that the rigidities found in much of the non-profit world need to go through serious adjustments and that will happen whether the occupants of the various ivory towers like it or not.

Investment thinking is being adjusted

All investment organizations are being caught in a pincer movement of lower investment returns in equity, debt, commodities, derivatives and cash concurrent with rising expenses for technology, compliance, marketing, and keeping their good people from going entrepreneurial either directly or to smaller shops, such as hedge funds. In this light it is interesting that Goldman Sachs^* will no longer produce research that is based on “growth at a reasonable price.” This is a policy that worked well in the mutual fund business for many years. In his leadership days at Fidelity Magellan, Peter Lynch was a major proponent of this strategy. In Peter’s search for good investments he found a large number of companies who were growing, not with a high growth rate but who were selling at prices that did not presume a continuation of their growth rate.

How are we are adjusting?

The first thing I do is look under the hood of various labeled classifications to see the spread of options that have been grouped under a simple label like growth or large cap. While it is useful to know how a manager performs relative to his peers under varying conditions, markets are not two dimensional up vs. down, most of the time they are in some form of equilibrium. The more you study people, the more different they appear to be. This is why an All-Star team picking the best player for each position often does not do well against a team of good players that has played together benefitting from natural leadership within the group.

I am looking to add a new fund to our portfolios. My key concern is whether the fund being examined, which is in a particular market phase, will add or subtract to the results of the existing portfolio.

One of the adjustments that I am making as I move away from labels is to look for good, understandable managers in broad categories. That is why I now group equity managers for my purposes under the banner of “equity exposure.” Because of the dynamic changes in the world’s intellectual leadership, I expect that the rate of adjustments will accelerate. I need to pay attention to these changes as they creep over the various time horizons that we must accommodate.

How do you expect to adjust to the future? 

^*Owned personally, by my private financial services fund, or both.

_______________________

Did you miss Mike Lipper’s Blog last week?  Click here to read.

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com .

Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.