“Straws in the Wind”: Predictions? - Weekly Blog # 890

 

 

 

Mike Lipper’s Monday Morning Musings

 

“Straws in the Wind”: Predictions?

 

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

 

                   

 

Predictions

Ever since humans have thought about the future, they’ve looked for clues about what the future might hold. Since very few stocks can be purchased and converted back into cash immediately with a profit on the first transaction day, equity investors are essentially betting on one or more perceived futures. All we can do is guess what may happen.

 

Since regulators frown on future predictions, particularly those that guarantee future events, investors and analysts scan both the past and views of the future to guess what may happen. The following are brief thoughts which may help subscribers think about the future.

 

From the Past

In 1934, the US Congress passed the Reciprocal Trade Agreement Act giving the President (FDR) the ability to negotiate reciprocal trade reductions. (FDR, with the help of his “Harvard Brain Trust”, was authorized to accomplish this mission. While they proposed tactics from the left, the current President may draw his approaches from the right. Both could be labeled “activists”.)

 

Today, the History Channel showed a two-hour program devoted to The Crash, The Depression, and FDR's actions. It was well produced, simplistic, and narrow, but the key facts seem to be accurate.

1. FDR's 1932 Presidential election had surprising support from Republican leaders J.P. Morgan Jr. and DuPont, the leader of GM.
2. FDR blamed the Crash and subsequent Depression on Wall Street and Banks.
3. FDR turned on them, which changed the way the economy worked.
4. The economy was not in condition to fight WWII at the beginning of the war.

 

As we have been told "History does not repeat itself, but rhymes." In general, there are two types of recessions, cyclical and structural. The latter takes longer.

 

2025

A year ago, very few analysts and perceptive investors would have guessed which four mutual fund peer groups would now be leading the year-to-date race. They are Precious Metals Funds +42.95%, Latin American Funds +24.50%, Commoditized Precious Metals Funds +22.60%, and European Region Funds +20.61%. The first and third are clearly based on gold, but the gap between the two appears to be unusually wide. Latin American and European funds having similar performance also seems unusual.  From an overall point of view these results suggest we have entered a new phase or cycle, with the probability that last year’s leaders won’t lead again for a while.

 

There now appears to be a need to fill manufacturing jobs on an overall basis. This is distressing for two reasons. The first is that hirers can’t find the right people who want to work in their plants. The second is that the new factories this administration is counting on will have difficulty reaching the productivity and profitability levels the optimistic people in DC expect.

 

The London Stock Exchange regularly publishes I/B/E/S estimates of S&P 500 quarterly earnings. For the quarter we are in, their earnings per share prediction is that we will gain +5.8%, while growing net income +4.3%. The +5.8% is disappointing, but the +4.3% shows how much the market needs buybacks. Moving to economic analysis from securities analysis, the low gains in net income will not generate sufficient cash to pay for capital expansion and the introduction of new products and services.

 

The weekly American Association of Individual Investors (AAII) sample survey has recently turned slightly bullish, quite a jump in three weeks. The latest week bullish/bearish readings are 37.7% and 36.7%, compared to 29.4% and 51.5% three weeks ago. Two comments are appropriate. First, this time-series has a good long-term record, although it has been wrong at turning points. Second, individual investors should not be traders who get caught up in short-term volatility.

 

2026

Venture Capital funds are having difficulty raising capital from investors and lenders. I suspect this is also true for the broader universe of private capital funds. Investors in small and mid-cap equity funds have become used to private capital funds buying their maturing holdings.

 

One commentator wrote that Warren Buffett’s Berkshire (*) sold bank stocks and has not sold any of its positions in Apple (*), Coke, and American Express (*) in its latest report. These stocks are price leaders and should therefore do relatively well in periods of stagflation.

(*) Positions held in client and personal accounts.

 

Question: What will make you transact this year?

 

 

 

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Mike Lipper's Blog: After Relief Rally, 3rd Strike or Out? - Weekly Blog # 889

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This Was The Week That Wasn’t - Weekly Blog # 761

 

Mike Lipper’s Monday Morning Musings

This Was The Week That Wasn’t

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

            

 

 

In the earlier days of popular US television there was a program of satirical commentary. It was an American version of a British program with the same name, abbreviated TWTWTW.

 

Looking for leads related to writing my weekly blog I studied the four-day Thanksgiving week and concluded there really wasn’t much there. Evidently, much of the normal global trading around “turkey day” saw volume at about half its normal level.

 

Nevertheless, there were some snippets which may point to significant trends in the coming weeks. I found the following briefs of possible value in thinking about future periods:

1. The dollar index has dropped to 105 from 115 recently.
2. Taxable bond fund inflows were the largest since the week of January 8^th, 1982.
3. The 2-year treasury yield remained stable at 4.48%, while 10 and 30-year rates were 3.70% and 3.75%, respectively.
4. S&P warned that the corporate default rate could double if inflation remains high.
5. Goldman’s strategist believes the bear market would last into ’23.
6. B of A predicts 2023 gains of 25% for copper, 15-20% for gold, 12-13% for US investment grade bonds, 7-8% for US Treasuries, and 5-6% for oil.
7. My son Steve commented for Royce Partners that small-caps on average gain 12% and 16 % in even numbered years during the November-April period. (These are Presidential and Mid-term years)
8. Howard Marks reminded us of the inevitably of change. He also commented that the private equity and venture capital markets are too crowded. (Remember the losing percentage of favorites at the racetrack.)
9. China Region US registered mutual funds were the worst performers in the shortened week. (Over the weekend there were riots in the industrial and financial capital of Shanghai and elsewhere. These riots were the response to hardships caused by lockdowns to prevent COVID-19 spreading. (Apparently the Chinese vaccine is not as powerful those produced in US and Europe.)

 

Many will view this list as bearish but recognize that pundits and at least half the politicians are bullish. They believe we have seen a stock market bottom and are discounting a rising economy. It is possible they may be correct.

 

To those who have studied economic and market history it would be ironic if they were right, as it would be just a matter of time before a major recession/depression occurs. Societies often need these dislocations to initiate the kind of structural change necessary to correct for deep imbalances.

 

Please share your thoughts with me.

 

 

 

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Mike Lipper's Blog: Trends: Deflation, Stagflation, or Asian? - Weekly Blog # 760

Mike Lipper's Blog: An Informative Week with Many Questions - Weekly Blog # 759

Mike Lipper's Blog: Are You Getting Value from Numbers? - Weekly Blog # 758

 

 

 

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A. Michael Lipper, CFA

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Securities Analysis as Taught Leads to Volatility - Weekly Blog # 705

 

Mike Lipper’s Monday Morning Musings

Securities Analysis as Taught Leads to Volatility

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

The long-term history of making money in the market is not  following the majority  with their money. In simple terms, choosing not to conform with what others are doing. Winning in the market means converting some of the wealth of others, often the majority, to our own. This maneuver requires using different approaches and tools than others use.

 

Sector Bets Fail to Produce Top Results

The academic course on Securities Analysis is taught as a companion course to accounting, or worse, macro-economics. Both work on past history and have precious little to do with future movements of companies, stocks, or economies. More useful studies would instead focus on profits and securities. 

All too often securities selection processes screen for companies which appear to be in the same industry, as measured by misleading government data. As a junior analyst I was assigned the steel industry. I quickly discovered that although the number of steel companies was small, it was a mixed bag of companies. You could divide the group by the location of their headquarters and proximity to critical resources, usually coal, or to a growing customer base. In this case an investor did far better with Inland Steel, based in steel-short Chicago, rather than in Pittsburg and West Virginia coal country. 

Another worthwhile distinction was the cost and quality of labor. In the early days of the externalization of producing payrolls, commercial banks were prominent. However, overtime they lost market share and eventually lost the entire market to independent payroll service providers who provided better services. They provided more help filing payroll tax returns and offered lower prices, due to their labor not being paid bank-type overhead. Today the payroll market is dominated by service companies with extensive and modern computer systems, which are good at servicing. (Our accounts own ADP.)

A final example is computers. Many of the large industrial companies manufactured the early computers, the biggest and best being IBM, a stock my grandparents owned. The key to their success was not only adequate technology, but superior leasing prices and great sales engineers. IBM’s top salesman regularly presented to Wall Street and was a missionary sales person. However, the industry changed from massive main frames taking up large airconditioned rooms, to desktop personal computers whose parts could be produced in low-cost regions of the world and could be assembled elsewhere. 

Dell started out by taking customer orders for computers which could be customize and air shipped to customers. Today, many believe Apple (owned in our accounts) is the leading company. This is the result of the late Steve Jobs’ focus on style and ease of use. His most important achievement however was handpicking his successor, Tim Cook, an expert known for supply management and development. What relatively few investors appreciate is its global network of Apple Stores and a growing mail order business generating repeat business, essentially building its own annuity business. (Remember, US automakers had market level price/earnings ratios when customers replaced cars every three years with newer models.)

Less popular ways of analyzing securities included: 

• Paying more attention to insufficient supply than excess demand.
• Focusing on differences in manufacturing approaches and costs.
• Understanding the personalities of key operational people vs known leaders and their educational biases.

We Don’t Create Winners, Losers Do

No matter how prescient and bright we are, to have great results we need others to create attractive entry prices and unreasonably excessive exit prices. Utilizing these as working assumptions, I am getting nervous about the flow of institutional and individual money in private equity/debt (private capital). For many years there were more good private companies offering participation in their attractive futures than potential investors. They attracted investors with relatively low entry prices. 

Recently we have seen a reversal, with a huge flows of institutional and individual money seeking to exit the public markets and enter the private markets. By definition, entry prices either directly rose or the firms had to carry senior debt prior to generating private capital returns. There is so much reversal of traditional roles that one of the oldest buyout firms, with a great long-term record, is converting some of their US and European investments to a publicly traded fund. For some of its investments Sequoia is trading up in liquidity.

One of the disturbing concerns in the privates market is the number of new advisers that have entered the market. They have increased the number of funds and are spreading the investment talent more thinly. In response, T. Rowe Price, an experienced investor in privates, is buying an existing manager to get the necessary talent in an increasingly competitive market. (Owned in Financial Services Fund accounts)

A number of well-known university and institutional portfolios have announced performance in excess of 40% for the fiscal year ended June 30. Some are probably reporting private investments with at least a quarter’s lag. (My guess is performance for the year ended March was better than the year ended June 30.) Most investors did not do as well and consequently some are likely to pile into an overheated private market with scarce investment talent. The history of investment returns is that it is extremely rare to find a manager who can consistently return over 20%, which is roughly three times the growth of industrial profits. The organizations that reported 40%+ profits undoubtedly benefitted from lower entry prices and better terms than is currently on offer. 

I am a long-term member of the investment committee of Caltech, an internally managed investment account with a talented staff. They have put a cap on their exposure to buyouts and venture capital. I applaud this decision because of the history of hedge fund performance. It shows that even very good hedge funds suffer when a minority of hedge funds experience serious liquidity problems. This was in part because of debt, but some of their holdings were also owned by trading interests desperate to liquidate some of their excessively leveraged holdings created by falling prices. This is a classic example of others causing some investors to have poor results.

Moody’s is also concerned about the rapid growth of inexperienced managers offering private capital vehicles. The credit-rater was criticized for the exponential growth of CMOs. (Moody’s recovered, and just this week was selling at a record stock price. Moody’s is owned in our managed and personal accounts.)

Historical Odds of Equity Bear Market

There is wisdom in the saying that history does not repeat (exactly), but rhymes. The ebb and flow of markets are driven by emotional excesses, with investors reacting to various stimuluses. I previously mentioned a successful pension fund manager liquidating his equity portfolio after it gained 20% in a calendar year, reinvesting the proceeds at the beginning of the next year. He produced a record absent of large losses, with reasonably good gains on the upside.

We may be approaching a “rhyming event”. I feel more confident taking a contradictory view when it is supported by large scale numbers. The US Diversified Equity Funds (USDE) have combined total net assets of $12.4 Trillion, representing 2/3rds of the aggregate assets in equity funds. According to my old firm’s weekly report, the year-to-date average gain was +21.01%, vs a 3-year average gain of +19.21%, and a 5-year average of +16.76%. More concerning is only 4 of the 18 separate investment objectives within the USDE bucket produced over 20% 5-year annualized growth rates. Of the 14 Sector Equity funds, only 2 grew +20%, and only the World Sector Fund average gained 20%+. At the individual fund level, only 3 of the 25 largest funds produced 20% growth rates. During the same 5-year period, the average taxable fixed income fund gained 3.34%, and the average high yield bond fund grew 5.47%.

Recently, a number of endowments reported gains of over 40% for their June Fiscal years, driven by successful private equity/venture capital investments. Some of these private investments were reported on a logged basis. Remember, in many cases they had spectacular performance through March, and have been relatively flat since then.

The cyclical nature of human emotions suggests that when earnings growth does not support lofty valuations, we are likely to have a “rhyming event”.

What do you think? 

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

https://mikelipper.blogspot.com/2021/10/are-we-listening-as-history-is.html

https://mikelipper.blogspot.com/2021/10/guessing-what-too-quiet-stock-markets.html

https://mikelipper.blogspot.com/2021/10/what-is-problem-weekly-blog-702.html

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Cash is a Four-Letter Word - Weekly Blog # 556

Mike Lipper’s Monday Morning Musings

Cash is a Four-Letter Word

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

                                   

We have been instructed not to use foul language in polite communication, (think of another four-letter word beginning with “F”). The time to recognize the biggest danger of a word and the concept behind it is when the word is most useful. That is exactly why I am calling to our subscribers’ attention the word “cash”. It looks like cash will be the only positive major investment class in 2018. Stocks, bonds and commodities, as well as some real estate and most currencies, except the US dollar, will all have a minus sign in front of their performance.

Major brokerage firms and various wealth management groups are heralding cash as the preferred asset class. Yes, it is better to make small positive returns than losing money. I have been studying this question for more than sixty years. Recognizing my historic bias based on my experience of using mutual funds, I use mutual funds as my primary filter. Utilizing the latest available data from the Investment Company Institute (ICI), with numbers as of September 30th, 2018, the aggregate weighted average cash commitment for all long-term funds (equity, hybrid, and bond funds) was 3.2% of assets. Most investment objectives have 5% cash or less as a percent of their total assets. This roughly represents under one year’s regular income production. Those reserves would only allow for a few additional names to be added to their portfolios and therefore would not normally be enough to make an enormous difference in performance. Unfortunately, many funds today are having net redemptions, which can only be handled by judicious selling. Many fund managers are concerned about a sudden surge in redemptions at the very same time of weak prices and limited available liquidity and do not want to commit all their cash to the market. There are two exceptions to the relatively low cash commitments, Asset Allocation Funds (18.25%) and Flexible Portfolio Funds (14.14%). While these funds often appear near the top of the performance parade in a declining market, over a full market cycle they are not even close to performance leaders.

Not only do I pound performance data concerning this issue, but I spend time with senior portfolio managers and presidents of fund management companies. There are all kinds of managers perceptive to future market declines and they often tend to be premature in terms of timing. Rarely do they commit the bulk of their reserves anywhere near the bottom. Matter of fact, when the eventual full recovery happens, they often have not fully committed to the markets moving toward new highs. Why does this occur?  Usually the recovery is based on anticipation of favorable changes not currently reported to be in place. Another reason is that emotionally the cash position is providing too much comfort. Buying after a meaningful decline requires some extra intestinal fortitude. Perhaps we should search for fund groups that replace the savior of funds relative assets with a rigorous long-term committed runner.

Recently we were able to restore appropriate equity fund levels to a cash flow account. This is an example of the advantage that some institutional accounts have over a fully committed personal account. Further, I suggested to a younger subscriber that he commit half of his cash reserves over the next six months to meet his retirement capital needs.

This post focuses on cash allocation as an input to a performance focused portfolio, which could be a semi-permanent element of portfolio management. There are other cash buckets such as planned external cash expenditures and purely opportunistic cash awaiting near term deployment. I do not know which cash bucket was used on Friday. Some of the financial sector stocks I follow showed transaction volume being 50% to 100% greater than Thursday’s volume. Friday’s combined NYSE and NASDAQ share volume was the highest since August of 2011. To me, it is more interesting to guess the motivation of buyers who are making commitments than sellers who are giving up. Traditionally, market analysts view this type of transaction volume as stock moving into stronger hands capable of tolerating currently perceived concerns.

For several long-term accounts that have periodic external payment needs, I have suggested that once a cash commitment is made it should be separated from performance analysis. This anticipates the actual expenditure but does not factor it into the asset allocation analysis. 

What to do Now!!

• Determine whether the resignations of General Mattis and the chief envoy to the anti-ISIS coalition are signs of continued political disruption which are of greater concern than trade issues. 
• Recognize that some of the signs of short-term capitulation appear to be evident, including Friday’s spike in trading volume led by stock price declines of former large “tech- leaders”. These stocks fell about 5% on Friday compared to 3% for most other stocks. The greater declines of NASDAQ stocks relative to NYSE stocks were probably the result of less liquid OTC trading books. 
• In a measure of price movements for the week, a chart in The Wall Street Journal showed that only 19 out of 72 price indicators rose, eight of them being currencies. 
• One measure of market sentiment is the often-mentioned American Association of Individual Investors (AAII) weekly sample poll of responses to the question of market direction for the next six months. The current reading showed that most of the sample were bearish or bullish, with a decreasing number being neutral. This is essentially a prediction of continued high volatility. Supporting this view are the 25 best performing funds for the week, six of which were invested in Futures, a leveraged way to bet on fast movements during a short period of time. 

We will only know later if we are at a bottom or not. What we should be doing is following the words of the famous Wall Street trader and a friend of my Grandfather, Bernie Baruch. Explaining his actions before a post-crash investigation committee of the US House of Representatives he referred to himself as a Speculator, which he defined as someone who looks to future time horizons.

Looking to the Future
Long-term value-oriented investors should change their focus away from expected current earnings reports. The great John Neff of the Windsor Fund developed his thinking as to the ultimate earnings power of companies during “normal” times. This allowed him to buy good companies at remarkably low price/future earnings ratios compared to high P/Es on declining earnings. This strategy worked for many years, both for the Windsor and Gemini funds.

Growth oriented investors would be wise to review the current issue of Barrons, which had a long article on a Venture Capital Round Table. I found two items of great interest. The three participants were investing in their expectation of future disruptions to various economic sectors: Financial Services, Supply chain Management, and Farming. To show how far out into the future their thinking extended, there was a discussion on manufacturing products in space, which they saw as a new commercial frontier. As a student of the market, the second thing I found of interest was that one of the three was a successful portfolio manager of an open-end mutual fund, T Rowe Price New Horizons (*). To some degree he and other open-end funds are investing in private companies because of the reduction in the number of attractive publicly traded small and mid-cap companies. Many of entrepreneurial companies are now waiting longer to go public.


(*) A long position is held in client and personal accounts.   



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

https://mikelipper.blogspot.com/2018/12/news-focus-may-drive-investment-success.html

https://mikelipper.blogspot.com/2018/12/investment-memory-friend-or-foe-answer.html

https://mikelipper.blogspot.com/2018/12/worries-2nd-derivative-3rd-degree-and.html

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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.