Where Are US Stock Prices Going? - Weekly Blog # 911

 

 

 

Mike Lipper’s Monday Morning Musings

 

Where Are US Stock Prices Going?

 

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

 

 

 

Time to Achieve

The old rule for publishers regarding future projections is to never state both a target number and a date certain. However, the result of that warning is a relatively useless projection for planning current actions. Unfortunately, I have views on both the target number and approximate timing, although neither are precise nor tied together. In this blog I share my thoughts with the hope that some are of value, and our trusted readers will share what they think are reasonable answers.

 

As a racetrack trained analyst, I believe the odds favor the US stock market reaching a multi-year peak in the foreseeable future. Consequently, my grandchildren and great-grandchildren will likely see nominal gains in their assets long-term. Careful readers will quickly surmise that I must have mixed views regarding my children’s market wealth prospects. Their results will be heavily influenced by their controlled spending and financial diligence, and what they want to leave to their heirs.

 

Current Market Dilemma

Most of the time a single investment attitude drives market prices. Today, there are two dominant thought patterns. The first is enthusiastic buyers who largely believe the President is in the process of restructuring the economy and therefore society. However, he is at a disadvantage of having only loyalists support him. (Loyalists generally do not pursue details of potential execution problems or even try to identify them to reduce political, functional, and court issues.) They think things are going well.

 

The second group is reluctant to make decisive decisions in the market. The $8 trillion in money market funds is one measure of their non-acceptance of things going well. Cash or similar investments are both a repository for normal operating reserves and future buying pools.

 

Incomplete Evidence

• Tariff impact: Consumers 55%, importers 22%, foreign producers 18%, and 5% evaded. (I suspect until tariffs are removed consumers will pay at least 90% of them, either in aggregate prices and/or in quality/quantitative shrinkage.)
• While the media and uninformed public focus on the Dow Jones Industrial Average (DJIA) and New York Stock Exchange (NYSE) volume and prices, they are missing a critical change in stock market structure. The year-over-year share volume has increased 40.88% for the NYSE and 80.55% for the NASDAQ, effectively double. (To some degree the NASDAQ volume includes inter-dealer trades to restore trading inventory positions.) Sometimes the two markets act differently. For example, on Friday the NYSE volume of advancing prices rose, as did total volume from Thursday. However, NASDAQ activity was the opposite, with lower volume and more decliners than gainers. A larger measure of the market is the Standard & Poor’s 500 (S&P 500), which is very near an all-time high.
• In the weekly survey sample of the American Association of Individual Investors (AAII), the percentage of respondents predicting a bullish market for the next six months dropped to 33.7%, while those predicting a bearish market rose to 46.1%. Just three weeks ago the ratios were 42.9% vs 39.2% in favor of the bulls.
• The current market and political situation resemble those of the late 1920s, which led to both the recession and depression. Both started with an overall increase in debt at the individual and business level. This was particularly true in the politically sensitive farm community, which was suffering from a change in foreign demand for its crops. (This time it’s a Chinese decline in demand for soybeans.) Small and medium-sized banks were having loan payment problems, which then led to imposing tariffs on foreign products and services. The current Federal Reserve Board is very conscious of this history.
• Another parallel is certain foreign governments recognizing the relative weakness of America and taking advantage of the situation by threatening further actions. This week Ruth and I spent time with the leaders of the US Marine Corps University who are preparing for a future different than the past. Similar efforts occurred before WWI and WWII, suggesting investors should think about structural changes to their investment policies.

 

Building a larger cash opportunity reserve may make sense. What do you think?

 

 

 

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Mike Lipper's Blog: A Good Time to Sell? - Weekly Blog # 910

Mike Lipper's Blog: Risks: Recession/Cyclical, Depression/Structural - Weekly Blog # 909

Mike Lipper's Blog: Tactical Headlines Show Strategic Clues - Weekly Blog # 908

 

 

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Statistics vs. Influences-Analysts vs. AI - Weekly Blog # 785

 

Mike Lipper’s Monday Morning Musings

Statistics vs. Influences-Analysts vs. AI

 

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

 

 

 

Raw Materials

When my grandfather entered the brokerage business in the early 20^th century there were no named analysts, only statisticians.  I believe the New York Society of Security Analysts (NYSSA) was founded in 1937 as one of the first local luncheon meeting groups. (Many years later I was elected President of this the largest analyst group in the world.)

 

A statistician deals with numbers, usually the limited amount published by companies and perhaps market measurers. Analysts however, as with military and commercial intelligence gathers, guess as to critical non-public information. One of the things I learned in the US Marine Corps was that before undertaking an assignment it is helpful to make a list of Essential Elements of Information (EEI). I was never given enough time to complete the list before moving out to accomplish the mission.

 

Perhaps it is ironic that some of the financial community, through the wonders of search programs on fast computers, are retrogressing to becoming statisticians.

 

The rest of this blog is devoted to possible influences that can lead to investment conclusions not connected by Artificial Intelligence relationships, perhaps because no one has made those connection in written texts. As with EEI, some of the influences do not lead to correct results but should be examined anyway. A wrong connection can prove to be inaccurate, but useful in improving the road to the right solutions. (This is often of great value to Caltech’s later research successes.)

 

Leading to Useful Conclusions

 

Possible US Stock market Direction

1. 83% of 2023’s gains in the S&P 500 thus far come from only 5 stocks.
2. Large market-capitalization stocks now have a preferred position. Year-to-date large-cap mutual funds have on average gained +9.85%, mid-caps +3.28%, and small caps +1.56%.
3. While a greater number of shares on both the NYSE and NASDAQ traded this week at rising prices vs lower prices, there were more stocks going down in price than up in both markets.
4. Do Treasury Bill yields predict inflation averaging 4.29% for the next two years, then dropping to only 3.69% over the next ten years?
5. A number of companies are in the process of meaningful transitions, probably suggesting their past financial statements are not particularly useful in predicting their future earnings power or stock price (Goldman Sachs, T. Rowe Price, and Disney are examples).

 

Where is the US Going?

The future belongs to the youth, as is usually the case. An upbeat hope was expressed for them by David Solomon, CEO of Goldman Sachs, keynote speaker at the NYU Stern School baccalaureate graduation. The brief talk was of interest to me for two reasons. First, it was the commencement for a grand nephew of mine. Second, Goldman Sachs is an investment in my client and personal account portfolios, which have performed well but is going through a difficult period as it restructures. While his comments were directed at the graduates, they also had relevance to Goldman Sachs and those in the investment business.

 

His comments are summarized briefly below:

• Life is a marathon
• Enjoy the hustle
• Good enough, isn’t
• Choose excellence
• Like connecting with people
• Spend time in pursuit of life’s goals
• Work longer
• This generation is going to Mars
• Focus on where to learn

 

A very different view can be gleaned from a survey of young people looking for their first job. The following are characteristics of what they are looking for and the percentage who want it:

• Flexible hours (68%)
• Retirement contributions (34%)
• Mental health benefits (28%)
• Student loan assistance (28%)
• Unlimited time for PTO (27%)
• A 4-day work week (26%).

 

China

1. Household bank accounts = $6.7 Trillion, which is greater than Japan’s GDP.
2. Private companies employ 90% of urban employees.
3. 20% of 16–24-year-olds are looking for jobs
4. The Central Government of China is holding meetings with governments in Central Asia. (The C5 counties of Kazakhstan, Tajikistan, Kyrgyzstan, Turkmenistan, and Uzbekistan. (All former members of the Soviet Union.) These countries are part of the critical rail and truck roads to transport both Chinese products and the natural resources of these countries. However, Chinese suppression of the Muslim Uyghur population in their Xinjiang region could cause problems. I believe the US will be involved with Ukraine for a long time as it is one of the critical players in the Black Sea, which along with the Caspian Sea is the western front for the C5 counties and China.

 

Working Conclusions

Even if you think you are just investing in the US, you are investing globally. Because critical linkages are between people, not texts, we are going to need more and better analysts throughout the world.   

 

 

 

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Mike Lipper's Blog: Insights From a Sleepy Week, Important? - Weekly Blog # 784

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Falling Confidence Beats Numbers but be Careful With 2nd Quarter GDP - Weekly Blog # 734

                                    

Mike Lipper’s Monday Morning Musings

Falling Confidence Beats Numbers, 

but be Careful With 2nd Quarter GDP

———————

Is a Structural Recession Coming?

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

Managing the News

The classical definition of a recession is two consecutive quarters of negative GDP. The first report for the first quarter indicated a decline of 1.4%. This was the headline, although the remaining bulls focused on subsequent reports adjusting first quarter results to a positive number that never made it into the conciseness of the market. Perhaps the message the market has taken is that this Administration is tone deaf. The White House had an afternoon and an evening to manage the news through its obedient media but failed to bolster confidence in the Obama team’s overall competence. It will be interesting to see how the second quarter GDP is handled after the July 4th holiday. If like the first quarter it is a negative, which looks more likely than not, the definition of two consecutive negative quarters representing a recession, may be viewed by some as fulfilled. If not, we may have to wait for an October surprise.

Current Pictures

Racetrack handicappers hope to find “smart money” to give them an edge. Two suggestions - Transportation and Speculators vs. Investor timing.

Transportation: One of the earliest stock market signals led to the Dow Theory, which states that a trend is likely to continue if the performance of the Dow Jones Industrial Average (DJIA) is confirmed by the trend of the Dow Jones Transportation Average (Rails) and visa-versa. The theory was based on industrial shares being more future oriented and rails representing freight that was actually sold. Applying this thought to the week’s performance. After 8 weeks of the DJIA declining, it was up 3 out of 5 days. However, the Dow Transportation Average was down 3 days this week.  This makes sense to me considering US rail traffic was down 5.4% this week. Of the 10 classes of freight, 7 were down and only 3 were up.

Market performance depends on which forces are dominant. Generally, there are more long-term investors owning shares traded on the NYSE than the more speculative holders that invest in the NASDAQ listed stocks. Larger passive index funds are more significant owners of “Big Board” shares. In terms of share volume for the week, only 47% of the NYSE shares rose vs 40% on the NASDAQ. In terms of transaction volume, the NYSE had 45% rising vs 42% for the NASDAQ. Clearly, participants in the market are not enthused with the current direction.

Since recorded time, civilizations have had economic cycles. While some were blamed on weather or plagues, most of the time the main cause was a prior foolish expansion that could no longer be supported. When this is recognized, it usually requires major structural changes to make progress. Is the forthcoming recession an advance signal of a structural depression? Quite possibly!!

A Problem Needs to be Addressed

The identification of the problem to be addressed is generally too simplistic. Global supply chain disruptions have almost universally been blamed on insufficient physical capacity. While temporary capacity limitations cannot be denied, the focus as usual is misplaced. There is a real shortage of qualified workers and most importantly of first line supervisors. In the US, we already know the ratio of publicly available job opportunities to registered unemployed has almost doubled. This is not purely a US phenomenon, as this week we were alerted to the UK’s ratio of opportunities/unemployed. There are now more opportunities than unemployed, probably creating a pattern I experienced in the late 1980s when we couldn’t hire sufficient qualified computer programmers in the US. We sought help from substantial software development shops in India. We were delighted when our designated vendor showed us the credentials of those assigned to produce the required software on a tight schedule. When it didn’t happen as planned, it became clear the good programmers we were introduced to were no longer there. They had left that employer for another, for perhaps an additional $5/week.

Today we are experiencing a decline in the quality and timeliness of deliveries at supermarkets, department stores, law firms, accounting shops, and hardware/software manufactures, etc. In almost all cases these organizations are desperate to find qualified workers, despite the high wages being offered. They have applicants, but they often don’t have the required work skills. The problem most often is that applicants don’t have the right attitudes toward work.

I suggest this is a generational problem, if not longer. The combination of stressed homes and a unionized bureaucratic school system is not producing disciplined students who value intellectual honesty, nor are they capable of budgeting their own time. To me this is distressing as a fiduciary and a consumer, but it doesn’t have to be that way. I am biased in favor of military training, sports teams, and religious organizations. In the US Marine Corps, officers quickly learn that the wonderful history of The Corps is due in part to non-commissioned officers, starting with Napoleon’s early rank of corporal. (Unfortunately, when cost- accountants run companies, they eliminate levels of supervision. They view it as overhead and don’t recognize that first line supervisors are the main cultural builders of a company.)

I hope we never again have a war that requires us to re-introduce conscription (draft). I say this for lots of reasons, including my grandchildren, great grandchildren, nieces, and nephews. However, as an analyst I am worried that at least half if not many more could not qualify to serve their country, due to their physical condition and mental discipline.

The likely business solution to those unemployed by choice is to encourage more automation. Much of the work done by low level workers has already been automated. Business and non-profits have already figured out that the cost of automation can be amortized over a few years, and so doing they eliminate a substantial number of problems in the workforce. Total compensation paid to lower-level employees vs. the cost of the facilities needed to support them does not offer sufficient pay-back.

This shrinkage of low-level jobs may lead to a permanent group of unemployed, at least in terms of the public record. While developed countries are moving down the replacement trend, it will take far too long to eliminate the unemployed problem. These concerns may be the underlying reason we cannot exclude the possibility of a structural depression.

Investment Conclusion

Be careful and invest wisely for the various likely futures and keep us informed as to what you are doing. We all need help.

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

https://mikelipper.blogspot.com/2022/05/inconclusive-but-trending-lower-weekly.html

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

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Respecting the Opposition & Market - Weekly Bog # 675

 

Mike Lipper’s Monday Morning Musings

Respecting the Opposition & Market

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

Competition Lessons

As a competitive fencer, I regularly fenced men who were better than me. For the most part they had longer arms and were probably better athletes, a real advantage in fencing. I was determined to score as many touches as possible to win matches. The first thing I had to learn was to respect my opponents’ skills and physical advantages. I thus developed what boxers call counterpunching moves. These mental attitudes followed me into the world of investing, where they are called contrarian.

Applications

I believe it would be extremely foolish as an American who served in the US Marine Corps to not identify China as a strong and growing opponent, one whose moves should be respected. Despite having fund investments in China for clients and myself, I am forced to acknowledge China currently having the most prudent central banker. Despite apparently coming out of COVID-19 first, it is retarding its growth by squeezing the non-bank financial providers, who are major providers of loans to the tertiary sectors of their slowing economy. The service sector and light manufacturers have recently grown faster than the rest of their economy but have little in the way of collateral available to be pledged. (Over the centuries there have been numerous Chinese commercial collapses.) As China’s economy has been a major importer of goods and services from the US and the rest of the world, a slowdown in China can create problems here and elsewhere. Unlike other countries attempting to fuel their recoveries, they are delaying going after credit growth outside the banking system. The authoritarian power structure is attempting to get ahead of a problem that has caused disruptions in the past.

A second application of the respect principle is to acknowledge the lessons of the stock market. The most consistent market lesson being the teaching of humility. Below are three historic examples of what may be its future progress:

1. A new bull market riding an economic expansion fueled by government spending.
2. A third term of Obama’s lack of progress.
3. A second coming of FDR’s elongation of an economic recession into a depression. 

I don’t know which path or combination of paths we will take, but I am prepared to be uncomfortable. Contrarian investing is uncomfortable and human beings take comfort in conformity. Contrarian investors must exercise patience, but as Saint Augustine said, “Patience is the companion of wisdom”, hopefully we have enough.

Current Confused Pictures

Hopefully, Positives

• A new generation of investors providing quick liquidity to the less liquid.
• Exchange Traded Products readily available to make directional bets.
• Equity Mutual Fund Holders redeem on average at 4.2 years.
• VIX readings dropping to 17.32 from 46.8 last March.

Perhaps, Negatives

• JOC-ECRI change in a year +88.47%
• Current performance of S&P 500 too high historically. Since 1926 it has averaged +10.3%. Do yearly returns need to decline below normal?

        % Change        Years

        72              1     

        20              2

        15              5

        12             10  

• Over the last year, 12 major currencies rose vs the US$ and 2 declined. Below are the top 2 currencies increasing vs the US$ and the two that declined.

     Australia   +24.4%      Korea       -2.3%

     Singapore   +23.0%      Hong Kong   -0.3% 

Interesting 12-month numbers for Standard Poor’s 500

             13.34%  Average S&P 500 Fund

             13.61%  Average of 30 largest S&P Funds

             13.91%  Gross performance of the stocks

The average large-cap core fund gained +12.53% and probably had 1-2% in cash, suggesting the superiority of passive investing comes from being fully invested, low turnover, and low fees. This could be a good model for all investors in funds or their own accounts.

Two Post-Mortems

While there were some typos in last week’s blog, it had two observations that proved to be germane. The first being Archegos, the family office that had their equity total return swaps liquidated to meet margin calls. We mentioned both Nomura and Credit Suisse had announced expected losses from margin transactions over the weekend. What I didn’t know, was that on Friday, if not before, Goldman Sachs (*) was aggressively liquidating the collateral supporting the Archegos account, where the market action in a number of  “thin” stocks was bothersome. Early trades in Asia were also quite heavy. Sometimes instincts moves faster than knowledge. 

(*) Goldman Sachs is a position in our private financial services fund.

Focusing on instinct, my smart wife Ruth commented to me that not only was the price of food going up at the Supermarket, but also the price of paper goods. This was borne out Monday when it was announced that the price of cardboard boxes went up. These two instances prove that investing is not only an art form but also an active-duty sport.

What do you think?  

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

https://mikelipper.blogspot.com/2021/03/the-biggest-risk-we-all-face-weekly.html

https://mikelipper.blogspot.com/2021/03/2-presidential-lessons-to-be.html

https://mikelipper.blogspot.com/2021/03/mike-lippers-monday-morning-musings.html

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Time to Review Investments - Weekly Blog # 629

Mike Lipper’s Monday Morning Musings

Time to Review Investments

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

If successful investing is an art form, as I believe it is, this could be a good time to review investments. Rather than briefly reviewing the existing portfolio at the end of each accounting period, I suggest one start over and begin with a blank canvas or piece of paper/screen. The empty space is a challenge and an opportunity. While none of us has the time and cognitive power to think through all the implications of COVID-19 and its chain reactions, it provides an opportunity to evaluate what a good investment philosophy would be for the evolving future, both for us and our responsibilities. Our lack of knowledge about the future does not excuse us from beginning the planning and restructuring process. One of the lessons from Newtonian Physics is that a body in motion tends to stay in motion. This works on the football field too and is true not only for us as individuals, but as fiduciaries for those who will be around long after we are no longer alive or in office.

Important Framework
Since the beginning of history, many military and state leaders have had to deal with present and future challenges. They have often had to deal with both simultaneously, tactics solving present problems while implementing strategies to secure the future. It is particularly important now, as our bicameral form of government has one body focusing on near-term tactics, while the other focuses more on the long-term strategies. In my view, the future will be driven much more by the perceptions of the individual members, than the leaders in The White House or the leaders of both houses. This belief is based on the presumption that most of the present leadership positions will be filled by different people in 2024. Something that will become increasingly clearer during or after the 2022 contests. Remember, the framers voted for a Republic and were afraid of an Athens type Democracy. Almost every political office holder is intensively aware of their next election, which for those in the house is every two years, and the senate every six years.

Essential Elements of Information (EEI)
Both voters and individual/institutional investors have consciously or unconsciously developed their own frameworks for decision making. Few if any will follow the old US Marine Corps field manual on developing military intelligence, perhaps an oxymoronic term. Nevertheless, I find it a useful teratological exercise to begin gathering information, some of which will be accepted as fact. The second step is to evaluate the credibility of each fact and the third is to assess the importance of each fact. (There are times when a “fact” that has medium or even low credibility can be viewed as important, even if wrong to some degree.) The final product of this process is labeled intelligence, which is then further subjected to the judgments of the command. Today, the media increasingly presents a biased source of “facts” and has low credibility. Many market pundits detect a presumed trend in the financial news and present it as an echo chamber. Others, with a knowledge of security price history and media pronouncements, believe the media follows the market, not the other way round. The second group has a better financial record.

Personal Philosophy (Biases)
I am confident enough to act, but also worry. My experience is that those who are the most confidant are often wrong, particularly at turning points. Learning to drive in New York City on one-way streets may have influenced my decision making. While I was not disturbed by walking down a one-way street because I could quickly reverse direction, I could not do this while driving down a one-way street. I could not turn until I reached an intersection going in the right direction. Likewise, I do not like an all stock, all growth, all US centric, all cash portfolio. Somewhat like Charlie Munger and Warren Buffett, who in addition to evaluating securities’ prices versus cash, also compare them to the securities they already own.

Again, like Warren Buffett, I have been wrong about rising inflation for the last ten years. I am very conscious that almost every government devalues its currency, either by changing its worth directly or permitting and perhaps encouraging inflation. Today, as most developed countries operate with a deficit, it makes sense to repay the increasing debt with a lower purchasing power currency. Even after the nationalist policy attempts by the current administration, I do not see a time when we stop utilizing products and services from beyond our borders. Thus, some foreign investments either directly or indirectly should be owned.

I do not pay much attention to reported earnings and book values. My valuation bias starts with net operating earnings, both before and after taxes. (I believe some reported earnings will be less than expected due to “other income” being smaller because of an increased debt load. I am a natural hedger, but not through shorting. Like Goldman Sachs used to do, I try to find companies or instruments that move contra to each other, e.g. airlines vs. oil prices.

Current Situation (Negatives)

• The fixed income yield curve is rising for maturities of 10 years or longer. Not a bullish sign for equities.
• Only 25% of weekly prices are rising for stock indices, ETF prices, currencies, and commodities.
• The internet services index rose this week and is the only one of 31 that track local markets and industries.
• The dominant mutual fund peer group this week was Asian equity funds. (Dollar finally declining and some economies possibly improving.)
• Major personal worry: We are heavy and long-suffering investors in securities of financial companies. Berkshire Hathaway has a similar sector focus and has been liquidating several financial stocks as well as cutting back on others.

Working Conclusion:
History is less valuable today than it has been for the past 100 years due to the pandemic shock. Complicating the analysis are:

• Price and structural changes likely to occur due to China’s shifting economics.
• The incremental costs of supply chains moving.
• The need to build medical and health reserves.
• Changes in financial contracting practices.
• Price and market-capitalization oriented indices not reflecting price trends in most non-tech, non-mega-cap stocks, which have not fully participated in the price recovery since reaching the bottom.
• The price recovery appears to have stalled out.
• A large handful of successful managers who feel compelled to make bearish statements questioning the ability of the March lows to hold.

While I do not know the direction and when the US stock market is likely to move, my working assumptions are as follows:

1. There is less than a 30% probability of the major indices testing the established lows and a much smaller chance of establishing a much deeper decline, perhaps 10-15%.
2. As most of our money is invested for the longer-term, I expect our equities to double in value over the next ten years. My statistical foundation for this assumption is that the average growth fund has generated a gain of 9% over the last 10 years. The average large-cap fund has generated a gain of 7% during this period. (Remember, we are using the average returns of peer groups and have a reasonably good chance through selection to do better.)
3. For the 10-year period, we expect the range of average diversified equity returns to be between 5% and 11%. This is below long-term historic results due to expected cost-push inflation, which cannot be fully offset by price increases.

What do you think? 



Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/05/top-down-sells-bottom-up-pays-weekly.html

https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/04/large-opportunities-and-risks-weekly.html



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Copyright © 2008 - 2018

A. Michael Lipper, CFA
All rights reserved
Contact author for limited redistribution permission.

Top Down Dictums Measured Digitally Are Not Designed to Win - Weekly Blog # 601

Mike Lipper’s Monday Morning Musings

Top Down Dictums Measured Digitally Are Not Designed to Win

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

Author's note
After producing our 600th blog I was prepared for more of the same numbers-oriented thought processes. However, life is full of surprises and mine included spending the last five days as a patient in the Overlook Medical Center in Summit, New Jersey. I was a victim of the Adenovirus F 41/42, which is somewhat like Pneumonia, but different. During my many sleepless nights I thought about the life lessons from my experience in the US Marine Corps and as a junior analyst at a trust bank. Those experiences helped prepare me to recognize the mistakes made through top-down decision making using digital analysis.

There is hardly an organized force today that does not mandate total compliance with the words and power delivered from those at the top to those  on the bottom. Usually, this means segregating people and strategies into narrow boxes through identified digital differences. We see this in Religion, political parties, non-profits, corporations and sports. In each of these human activities we assign labels like believer, progressive, conservative, socially responsible, gender, left-handed hitter, or growth stock manager.

Organizations marshal their people and resources to deploy them in the chessboard of life using these differences. Notice, we tend to play down whether a person is particularly competent or nice, or has a good set of morals. Sometimes this leads to extreme or unwise behavior. For example, as a young father of little league children I watched some fathers urging their children to hit left handed in baseball, because it was mathematically accurate that left handed hitters had a shorter run to first base than the more numerous right handed hitters. Not much attention was paid to the young player's skill, either at bat or in the field. Getting on base however more than satisfied the father, regardless of what it did to the young person.

I saw an analogous event while I was a communication platoon commander in the USMC. I commanded forty-two mostly young Marines. These marines fit into the Table of Organization of the Corps, which in theory enables every such unit to have the same capability as every other. Each Marine is also considered equivalent to any other, any place in the world. As was often the case, my young marines and their slightly older non-commissioned officers quickly showed me the different skill sets of the troops. If we were laying down a wire network, some Marines were quick to use the paths and roads in the area. Others took more time and strung their lines in hiding, preventing them from being disrupted by their own or enemy movements. We had a few Marines that were champion tinkerers and could make old equipment better than new.

As a junior analyst at a trust bank in a bull pen of other analysts, we produced multi-page reports for the trust officers so that they could pick out a few lines for their customers. When I looked at my fellows, I noticed a few who were quite plugged into the brokerage community and were quite good at finding promising new issues. Others recommended unexciting stocks that rarely went down more than the market. Some analysts found companies that had prior problems and had solved them, or at least largely addressed the issues.

Clearly, each of us were different and could have been used differently. Recently, I have been involved with a few non-profits and corporations who wish to appeal to clients through various ESG actions. For the most part these groups don't have in-house investment experience, so they follow a “check the box” strategy in terms of age, gender, or ethnicity. In a discussion with a consultant pushing for more women on boards, she never once mentioned an applicable skill set. I pointed out that women have risen to responsible positions for some time and provided an example. In the 1990s, before I sold the data bank to Reuters Group, three out of our five offices were managed by women with responsibility for the bulk of the employees. They were not in these positions because they were women, but just happened to be the most qualified people for the job.

Selecting Mutual Funds 
Our principal job is to select and manage a portfolio of mutual funds for clients. When we got started there were relatively few funds and competitive leagues. We developed a large number, probably more were needed, and used those peer groups to help with investment selection. During short time periods, those portfolios with a good portion of their money in similar securities tended to lead or lag more diversified portfolios. For conservative longer-term holders this approach may be preferable. There are times when how a fund handles significant sales or redemptions can make them attractive or unattractive. For example, if a fund that is growing needs to add new names to the roster, picking new names that are not as good as others in the portfolio may end up diluting the portfolio. On the other hand, a fund that is in net redemption can improve its long-term outlook by selling their less attractive names, increasing ownership in their better bets.

Conclusion 
The value of particular people is more important that the labels that many put on them. People make the difference, not the labels.



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/10/two-questions-length-of-recession-near.html

https://mikelipper.blogspot.com/2019/10/things-are-seldom-what-they-seem-weekly.html

https://mikelipper.blogspot.com/2019/10/mike-lippers-monday-morning-musings.html



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Worries: 2nd Derivative, 3rd Degree and Surprises - Weekly Blog # 553

Mike Lipper’s Monday Morning Musings

Worries: 2nd Derivative, 3rd Degree and Surprises

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

                                         

The job of the analyst and leader is to worry about the things that most others don’t worry about. The worries that most are concerned about won’t happen as imagined, but others will. As is often the case with jargon, those in the know want to protect their position by defining a situation in terms that only they understand. The concept of the second derivative is known by sports people, hunters, and drivers. In plain language, the first derivative is the speed of something moving and the second is the rate of change in that speed. When driving, we note the speed of one car overtaking another. What is of significance to avoid accidents is whether the overtaking vehicle is accelerating or decelerating. The risks of an accident happening is much greater if the overtaking vehicle slows upon passing, creating an unsafe gap between the moving vehicles.

Applying the 2nd Derivative
Quite foolishly, far too many investors believe that reported earnings will dictate future values. Foolish because in today’s world the validity of reported earnings is as accurate as the former Chinese Premier’s distrust in reported GDP numbers, thinking of them as man-made and not reflective of reality. One of the better consulting firms, the Boston Consulting Group (BGC), has published its “Value Creation Insights” on corporate activity. BGC noted that current prices include current expectations. This suggests that their clients can only raise stock prices by accelerating expectations, or for numbers-oriented people, by driving the second derivative higher than the first.

The problem facing investors today is that the current and expected 2nd derivative is negative. Through the third quarter most American companies were reporting record results driven by high profit margins. These expanding margins were the result of sales growing way above trend and by utilizing underused human and plant capacity. Part of the driving power of these results was supplied by overseas workers, customers, and facilities. Most non-US markets have recently declined. The media and others have attributed this to the current trade conflict. While this is somewhat true, I believe an equal if not greater impact is due to consumer demand slowing and higher wages being paid.

Will the Saturday Night Truce work?  
Clearly the Saturday night truce could dramatically change some of the trade issues, while creating others. While markets are likely to move this coming week, my guess is that the earliest we’ll clearly see the impact will be the following week. Although that is likely to be a knee-jerk reaction, as the details will not be forthcoming until next year. Nevertheless, as much as I would like to be wrong, I do not think that trade itself will be enough to get the first and second derivatives moving in the right direction for investors. This is the logical view.

The Absurd View
Part of the training at my two educational institutions, the racetrack and the US Marine Corps, is to always be on the alert for surprises. Some of them may be so surprising as to be considered absurd or unbelievable. In that light I suggested in last week’s blog that the US stock market could go to a new high this year. My reason for suggesting it was that in the light of the declines of the past few weeks, no one would have such foolish thoughts. Foolish me, I discounted radical swings in sentiment. Global stock markets rose last week, probably in anticipation of a favorable result. Of the 30 top movers among the 72 market price indicators, 26 were stock market indices and only four were commodity indices. Thus, one can see that changes in sentiment drove stock buyers more than they did commodity or currency players. With the Dow Jones Industrial Average gaining +5.59%, S&P 500 +4.46% and the NASDAQ composite +6.19% in the week, new highs are only +4.81%, +5.81%, and + 9.04% respectively away from their former peaks.  The absurd goes from impossible to possible and some may even say probable.

Whether or not the numbers play out as suggested, the key takeaway for investors is to expect surprises, some good. In the long run markets move on supply and demand, which may or may not be seen. However, in the short-term, changes in sentiment can make for dramatic moves.

The 3rd Degree
People need to find others to blame for their misfortunes. If they can find the culprits who did this to them the culprits can be severely punished and possibly get restitution, ensuring this problem won’t happen again. To accomplish this corrective goal requires some hearing in the court of law, or more quickly in the court of public opinion via the media. This need has been present in societies throughout history. Because the guilty can be deceptive, they need to be questioned sharply, with or without appropriate protections. If headlines are generated, the prosecuting attorney or media can go on to bigger and better things, but this will not necessarily be better for the victims.

Despite repeated trials in court or the media these offending problems continue to reappear. Why? I suggest there are two fundamental generators of these problems. The first is the so-called victim, who in these circumstances possesses bad judgment. Bad judgment is often sourced from a school or the media trying to educate quickly, but not thoroughly. A similar source may be the staffs supporting various politicians, as well as the politicians themselves.

Since the main culprits won’t acknowledge their culpability, there is a search for other perpetrators. Thus, all that serve as fiduciaries for others, as members of boards and advisers, are at risk of entering a 3rd degree chamber. Prosecutors are not interested in the number of years where things were done right, or the elements of sound judgment that didn’t work at times,  suggesting a failure to process rather than the quality of judgement. Did you know, if not, why not? Type of questions. This is exactly why when sitting on a board or working for them I ask a lot of questions, with the hope that at least the questions, if not the answers, will hopefully be remembered in the minutes.

The reason for bringing this up now is that it has been a long time since we have had a bunch of scandals. (Because of human nature I suspect malicious things happen all the time and only occasionally bubble to the surface.) Often when the economy is not performing well there is a public need to find culprits. We know that some things will surprise people and therefore there will be a need to shift blame. These issues may not come out in force until there is a recession, which will come at some point.


Question of the week: 
What do you think and are you planning to do anything about it? 


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

https://mikelipper.blogspot.com/2018/11/on-road-to-capitulation-and-recoveries.html

https://mikelipper.blogspot.com/2018/11/selectivity-over-factors-weekly-blog-551.html

https://mikelipper.blogspot.com/2018/11/history-guide-not-map-or-trap-weekly.html


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Committing Reserves - Weekly Blog # 547

Mike Lipper’s Monday Morning Musings

Committing Reserves

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

Any student of military history will be presented with the reasons why important battles were won and lost. Often the critical decision was when and how reserves were committed, both in defensive and offensive phases. The same thing can be said for managing portfolios. The standard battle structure used by the US Marines for maneuver units is, two up and one back, plus support units. On offense, reserves are committed to replace the tiring front line units so that fresh troops can pick up the pace of an attack. On defense, if the front line forces are pushed back, troops held in reserve are committed to stop the breakthrough, where enemy's troops are expected to be tired and somewhat disorganized. The keys to committing reserves are the factors of time, surprise, and location.

Applying these military lessons to portfolio management, the following principles come to mind:

1. Reserves need to be of sufficient size to maintain or regain the momentum. The two up and one back suggests that reserves should be in the range of 1/3 of the active forces.
2. Reserves should not be committed piecemeal, as they lack sufficient force to accomplish the main objective.
3. Reserves should not be committed too early, suggesting a 25% decline from the prior peak might give sufficient space to pick up bargains.
4. After committing reserves, be prepared to assign additional assets in order to preserve critical resources.

Husbanding Reserves
This week both Goldman Sachs and Morgan Stanley reported unexpectedly good earnings, which the market treated positively. In carefully reading their release and listening to their conference calls, there were some cautionary notes. Both are watching very closely for any weakness in their credit extensions.

Awaiting Direction
Along with other money managers, flows were slower than earlier periods. Modest earnings gains are expected by various analysts. The biggest gains are expected for the Russell 2000, which may be influencing the proportion of firms becoming profitable.

The average Large-Cap growth fund is up +9.09% YTD and +12.72% for five years, with both exceeding the average S&P 500 Index Fund performance of +4.78% and +11.52% respectively. The period of superior performance for index funds may be over for a while.

Major Commitment
Finally, on Thursday there was the announcement of Mass Mutual selling Oppenheimer Funds to Invesco for approximately $5.7 Billion, largely in stock.

In looking at the price, there are two interesting points. First, the rumored price was $5 billion in cash. This is roughly equivalent to $5.7 Billion in stock, in my opinion. Second, the seller wanted to stay invested in the mutual fund business. I view both as a vote of confidence in the business. Invesco has good distribution capabilities in Europe and Asia, which may be effective in selling the Oppenheimer Funds.

 Mass Mutual as a knowledgeable seller becomes the largest shareholder in the combined company and obtains a board position. They like the outlook for the business but probably don’t like the outlook for Oppenheimer’s retail fund operation. Mass Mutual has retained their ownership of Barings, an institutional player.

My clients and I own positions in a number of their domestic and international fund management companies.

Prudential Needs Smaller Reserves
Prudential Insurance is no longer labeled as a SIFI (Strategically Important Financial Institution) It did not have to contort itself as Metropolitan Life did to shed the title, it just had to be more patient and work Washington well.

Risk Management, not a Perfect Defense
Risk appears to be singular but in reality it encompasses a number of known and unknown risks. This multiplicity of risks makes it difficult to model as a single risk factor. This is particularly true due to a growing list of unknown risks. Thus, there is no such thing as a riskless investment.

Some Portfolio Managers Reduce Market Risks
The following brief comments are derived from reading the quarterly institutional reports from T. Rowe Price and Wasatch Funds, that we and our clients own. They are derived  from portfolio managers who also look at broader issues that may be of interest to our subscribers.

1. In the third quarter and continuing into the fourth quarter, security valuations didn’t seem to matter much. High Price/Earnings ratio stocks outperformed those with lower Price/Earnings ratios.
2. Investors remain complacent to the potential of future shocks.
3. A number of portfolio managers are pruning their portfolios by selling into strength.
4. At least one perceptive portfolio manager is taking advantage of the fall in Chinese stocks prices by broadening and deepening her commitment to non-tech Chinese stocks.
5. Concern for the housing outlook favors beneficiaries of short-term and longer-term lower commodity-priced inputs.
6. Trimming some Software-as-a-Service stocks.

In our private financial services fund I personally own shares in the publicly traded T. Rowe Price stock.



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Critical Time for Critical Questions - Weekly Blog # 518

Introduction

Critical Time

For the US stock market, we may be at a critical time or juncture leading to materially higher or lower stock prices. Are we pausing in a correction or are we on the way to a full bear market of about twice the decline already experienced, or worse? Are we in the process of successfully testing the February bottom?

To me, as both an analyst/portfolio manager and a handicapper trained contrarian, I think the odds are good for the first, but not the second. To me, as an observer at the  race track, favorites typically win about a third of the time. I look at sentiment readings and the mainstream media for clues. Given three choices, bullish, bearish, and neutral, the latest weekly survey sample of the American Association of Individual Investors (AAII) has pushed the bearish button to being a slight leader. Normally, most investors are bullish most of the time. Their views are being reinforced or led by large elements of the coastal media who are proclaiming the market slide as confirmation of the supposed failures of President Trump.

Using my training as a racetrack handicapper, I suggest the odds we are experiencing a successful test is better than 60%. Those odds are in the same neighborhood as investors’ own various mutual funds which are 67.74% in equity funds. (Strange how the 2/3 to 1/3 split is similar to the standard attack format for successful battles won by the US Marines.)

As focused as most investors are on the next general direction for the market, the key is not the tactical direction, but the answers to long-term strategic questions. Just as at the track, the key to walking away a winner in dollars is how one handles the betting money. The key to being a winning investor is reasonably answering the following strategic questions.

Critical Questions

The single most important question (usually not answered) occurs when someone asks for a stock recommendation. Until a stock is no longer trading, history suggests that it will have a plus sign in terms of its performance for some period. Thus, it is not whether this stock will rise in price, but whether it will rise over a pre-designated time span. Just as it is a mistake to bet on every race during your day at the track, it is also a mistake to have a single portfolio that one believes will be a winner for the current, intermediate, and long-term. This is particularly true today, with half the stocks disappearing over the last twenty years or so.

We have been an advocate for dividing institutional and individual portfolios into separate time-span portfolios. Different securities are likely to dominate the short-term or Operational Portfolio, Intermediate or Replenishment Portfolio, longer term Endowment Portfolio and the beyond the control of the current investor Legacy Portfolio. I would be pleased to work with subscribers to construct these portfolios. The following are not recommendations but illustrations as to what we would be looking for in the candidates:

• Short term/operational Portfolio - mutual funds with a balance of short-term high quality fixed income and high quality liquid stocks
• Intermediate/replenishment Portfolio - medium price/earnings ratio stocks paying average dividends
• Longer-term/endowment Portfolio - mutual funds of established growth companies with high return on tangible assets and p/e no more than 150% of market
• Legacy Portfolio -  funds or companies that look to the next generation of leadership e.g. Berkshire Hathaway*

*Held in client and personal portfolios

One of the most difficult questions to deal with is the measurement of success. To the extent that a portfolio is meant to produce capital (principal, income or total return), the clearest measure is absolute return. If there is a competitive need to be fulfilled, then an external index or indices are needed. (University endowments are in competition to get the best faculty and foundations are in competition to get grants.) The critical key in choosing a measuring rod is how the index is constructed and changed, the rigor of measurement, data availability, and whether the proposed portfolio will be restricted to elements within the index. I have a bias in favor of using mutual fund indices and averages when they qualify. Some of the areas they cover include market capitalization, growth, value, and core, world equity and debt, sector funds, mixed asset funds, various types of bond and credit funds, and different types of money market vehicles.

Be very careful not to lump conventional mutual funds in with Exchange Traded Products (Funds and Notes). While both are registered under the Investment Company Act of 1940, they are designed and largely used differently than the larger universe of conventional mutual funds. Exchange Traded Products do not have cash to buffer market price changes and flows, they have relatively fixed portfolios and are primarily used to express specific long or short points of view. The bulk of their volatile flows come from trading organizations or advisors who trade their accounts. Recently, they have not been particularly good at handling these difficult markets. According to The Wall Street Journal which tracked the price performance of 72 stock indexes last week, including currencies, commodities and ETFs, there were no ETFs in the top 21 or bottom 27 slots. This suggests to me is that the market is reconstructing the winning and losing groups.

The purpose of comparing performances of various instruments is to create awareness of what is going on and to manage expectations. The result of measurement leads to an understanding as to what portion of one’s portfolio is for investment or speculative purposes. The answer is not always found in the nature of the instruments, but how and why the owner uses them. The market needs both investors and speculators as they often trade with each other to enlarge or reduce their universe. The changes in the value of investments and speculative vehicles are dependent on these trades. Market prices don’t generally move a lot unless investors are selling to speculators or the reverse. For example, during periods of high price momentum, with the exception of scale orders to enlarge or reduce the size of a position, wise investors should leave the action to the speculators.

Questions of the Week:

How many, if any, sub portfolios do you use?
What is the ratio in your own account of investments to speculations?
__________
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While Most Look to this Week, I Look Long-Term

Introduction

The almost exclusive focus of many US citizens and those that have investments or trade with the US is on the results of the Presidential election. Historically this is foolish. Going back through recorded history of elections from around the world, we have learned that even if they want to, politicians do not deliver on what they say. In this particular election this view will be most likely sustained. I am much more focused on who will be the ranking minority member of important Senate committees. That individual's political skills and priorities will give us the most useful clues as to what will pass through the House-Senate reconciliation committees when the two houses pass different pieces of legislation.

The second focus should be on the various strengths of the "K Street" lobbyists on both legislation and executive actions. All of these considerations are short-term and will in all likelihood will be overcome by currently unseen or at least unpredicted events.

With so much focus being paid to the very immediate, as a contrarian I look to the longer term implications of this and the various European elections that will occur within 12-15 months in the future.

The Losers

I don't know who the winners will be despite my personal opinions on who should win. However, it is easier to identify the most likely losers. As an old broadcasting stock analyst in years past, I could count on a surge of political spending on broadcast and print media advertisements during election season. These buys helped the cyclical earnings pictures of the media companies. It also set the need for political organizations to raise substantial amounts of money to pay for these ads. In handicapping an election the candidate that raised the most money would be the betting favorite to win. The election in 2016 is different. One side clearly raised the most money, but as always big money comes with ties. Either because of these ties or other reasons the big contributors may not have bought the election. At any rate they had to pay much more than candidates who used virtually free media exposure who are getting a much smaller cost for exposure and getting a higher return on their investments. The longer term implications of this condition is that the broadcasters and producers of print publications are going to be less valuable in the future. Ultimately the real losers from this switch to sound bites over the internet may well be the voters. There will be a dearth of long form, well researched, unbiased journalism. Unfortunately as of the moment not many people will pay for it. (I hope I am wrong as I personally own a fund that owns media stocks. Luckily they have substantial investments in domestic and international cable and internet investments.)

An Investment Research Parallel

Whenever I speak with CEOs of public companies or fund managers, the older ones complain as to the quality of research being produced. I believe it is the result of a similar economic pattern that will be applied to many media stocks. The market will no longer pay for the time and energy of in depth research. One of my great learning experiences was commuting with Arnold Ganz, my brother's research partner. He regularly produced forty page research reports that were of the quality of legal briefs. The analyses spent a great amount  of time on the motivations of managements as they chose different approaches to the future. There were a handful of pure research firms that did nothing but produce high quality research. None of these independent firms exist today, but I believe there are a few individual analysts with a small market audience working by themselves or very small groups.

Two Statistically Significant Events Happened This Week

After 108 years the Chicago Cubs won a thrilling World Series. The Cubs win is significant for long-term investors for two reasons. The first is the unfortunate need for patience along with continued efforts to improve. As an entrepreneur, investment manager, and investor I have experienced various plans for the future that have not worked out. For example in the third quarter many publicly traded fund management companies reported earnings declined greater than their revenue declines. Instead of operating leverage working for them as usual it worked against them. They elected to keep on spending for talented people and technology rather than cutting back. These managements were practicing what I learned in the US Marines. I was told by a senior officer we never get judged by the success of plan A, because we never get to complete it. We get judged by plans B through Z or some combination of those. The lesson was in combat one needs to be able to adopt to change conditions and execute the best one can. This philosophy rests on intelligent patience of looking for the new opportunities as they evolve. Unfortunately when we teach about dealing with life's investment problems we don't teach patience. The success of the Cubs was based on the patience of their fans, but also adopting a strategy that another successful team previously used in their winning season.

The second political and investment lesson from their victory was that the weight of money doesn't always win. Growing up in New York City it was easy to cheer for the New York Yankees, particularly after the New York Giants were suckered out to move to San Francisco by the transplanting of the Dodgers to Los Angeles. After all, the Yankees had the biggest stadium, largest TV audience and earned the most money. That worked well until some large financial institutions determined that they did not manage their farm teams well enough to produce new superior talent. This year's World Series was between the Chicago Cubs and the Cleveland Indians. Neither team benefited from the bi-coastal television audiences available to the Mets, Dodgers and the Yankees.

Often in the investment world there is the belief that the largest players can get better results because of their size and presumed talent. This is often called the “weight of money argument.” I first came into contact with this concept when I was leading an around the world mining focused analyst trip for the New York Society of Security Analysts. One night on the trip I got a call from the senior international investment officer of a large US investment group who was inquiring as to what were my trip mates’ reactions to our visits that day with some Australian mining companies in which he held big positions. Considering how deeply his firm did their research, I said I could not imagine that we learned anything that he did not know. That was not his reason for asking me in the middle of the night. He was interested in my guess as to whether the analysts would be likely to recommend the purchase of the stocks in which he was interested. In effect, he was attempting to gauge the future value of those shares based on the weight of money. This approach is not different than those who today are betting on which political campaign will win on the basis of the amount of money they have to expend. With the Cubs’ win this year it may not be an effective strategy to bet on the bigger payrolls of the other teams.

The second statistically noteworthy event of the week was the ninth consecutive day of the S&P500 decline. This has not happened since December of 1980 or before many of today's money managers were in the business. While the aggregate decline over the period was only

­­-3.1%, many of today's more trading-oriented managers are used to being able to trade successfully against a trend. In the commodities world this is called trend following and trading. The importance of this event is not its direct impact, for on October 19th, 1987, the market declined -20.47% and over a two day period in 1929, -22.50%, but rather a signal that we have entered into a different type of market than many of today's investment managers and investors are used to. They may have to exercise some patience as they search in their normal playbook for plans B-Z and adopt to changing conditions. This week could be interesting for them.

__________

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