Investment Time Horizon Should Pick How You Measure the Results - Weekly Blog # 921

 

 

 

Mike Lipper’s Monday Morning Musings

 

Investment Time Horizon Should Pick

How You Measure the Results

 

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

  

 

 

Current Situation

Billions of people invest directly or indirectly in US securities markets, with each having somewhat different motivations and thoughts about what they are doing. Since we don’t know these people and the way they think, we simply group them into buckets. I have found the intended investment period often defines how they invest and for what period.

 

My outlook is of someone who has served families and institutions, and I tend to think long-term for them. As most money invested in mutual funds is largely for retirement and most institutions are designed to pay out their assets over an extended period of many years, they too have a long-term time horizon. (Unfortunately, this focus on the long term does not come with a knowledge of what the future will bring in terms of risks and rewards.)

 

The media concentrates on “news” and fills space with the current chatter about the present and the next expected announcement of note. Most security salespeople and money managers believe potential investors are primarily interested in the present and that is the focus of their sales pitches.

 

These two different focuses have led to two very different market structures. The hyper action-oriented players dwell on any market development that leads to a move in stock prices. They celebrate the percentage gains of interim results and prognostications. Those who use securities to meet future payments are concerned about anything that might reduce these payments in terms of future purchasing power. A possible tell-tale signal of a threat is the sale of securities by supposedly knowledgeable investors.

 

This is the tug of war between those seeking near-terms rewards and those worrying about the loss of worth of some future payment. To satisfy both camps the stock exchanges publish the volume of shares sold at higher and lower prices and the number of issues which rose and fell each trading day.

 

In the latest week there were only four trading days and one of those was half a day. On the last day the volume of shares traded on the NYSE was down by approximately 2/3rds and by approximately one half on the NASDAQ*. (In the current market environment, I pay more attention to the NASDAQ, as it has risen the most this year due to having more “Tech” companies, whose stock prices are more volatile than those on “The Big Board”. On Monday the 4 indicators were larger for the NASDAQ and on Tuesday the NYSE saw better results. This see-saw pattern has occurred frequently throughout the year.) For the week, 65 % of NASDAQ stocks rose in price vs 61% for the NYSE.

*Client and personal accounts own shares in NASDAQ.

 

In terms of looking at the future there were two interesting notices. The Conference Board Consumer Sentiment Survey was 89.1% vs 92.9% the prior month. The American Association of Individual Investors (AAII) saw a drop in bullish sentiment for the next six months in their sample survey, dropping to 37.4% from 44.1% the prior week.

 

Understanding the Measure

Most of the chatter about this change focused on the percentage change from the period immediately prior. However, there is another way to look at the results, the way an actuary would in determining the chance of a certain event happening. This is done by reviewing the entire history of the statistical sample, including any possible period where that event could reappear and at what frequency. For example, one chance out of fifty years, or every 84 months, or something similar. History traced through geological discoveries has recorded cycles of expansions and contractions with some regularity. It is much easier with regular barter or the development of money.

 

Said simply, when there is a shortage of supply over the level of demand, prices go up. When there is more supply than demand, prices drop. Climate also impacts agriculture, as does the effort of humans. The supply of money was a recent concern, which has more recently shifted to concerns about the supply of credit and certain natural resources. In all cases, it is the imbalance of critical items which moves prices to a point of excess, which causes a reversal.

 

Small reversals happen more frequently than large ones, often occurring within a single presidential term. However, small reversals periodically stretch over two or conceivably three terms. In trying to avoid or stop small declines, the application of well-meaning changes can trigger bigger declines, which we label depressions.

 

Addressing the economic hardships caused by the cost of fighting WWI led to an extended period of debt expansion, which initially hurt the farming communities. This led to the application of tariffs to protect small banks which extended loans to over expanded farmers and farm equipment dealers in critically important mid-western senate seats. Simultaneously, the public became enamored with the use of credit in an already highly priced stock market.

 

The market crash of 1929 caused many people to lose money in margin accounts, along with many of their brokers. The market reached a bottom in 1931, but people were scared by what had happened. In 1932 they elected FDR as President as a protector of the banks, and he closed all the banks in 1933 in an attempt to restructure society. Even though FDR lost most of his battles with the Constitution and the Courts, he initiated various government agencies that mismanaged the economy until we entered WWII, which he helped start in both the Pacific and Atlantic. The US recovered slowly after the war and subsequent Korean Conflict, although some stocks listed on the NYSE did not reach their 1929 highs until the mid-1960s with the discounted dollar.

 

Semi Parallels Today

There has been an expansion of debt both at the federal and individual level, with bankruptcies currently rising. At the same time, prudent constraints on the financial community have been reduced or eliminated. Additionally, we have an underequipped military, including Navy, Air, Space, and Coast Guard not ready for a multi-front war.

 

Conclusion:

We don’t know when the next decline will happen, or if the depth of the decline will morph into a depression. However, we should resist being fully exposed to rising gains in the non-public market while we experience a stagnant private economy. It is possible gains achieved in 2026 may be expensive in the long run, so be careful.   

 

 

 

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Mike Lipper's Blog: Tis the Season of Joy & Reflection - Weekly Blog # 920

Mike Lipper's Blog: Are Investors Seeing a Change? Politicos Are Not - Weekly Blog # 919

Mike Lipper's Blog: On The Way To Casualties & Eventually Riches - Weekly Blog # 918

 

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Are Investors Seeing a Change? Politicos Are Not - Weekly Blog # 919

 

 

 

Mike Lipper’s Monday Morning Musings

 

Are Investors Seeing a Change?

Politicos Are Not

 

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

 

 

 

Was the latest week instructive?

During the low volume week: the DJIA fell -0.51%, the S&P 500 fell -1.07% and the NASDAQ fell -1.69%. One does not know a trend is over until a meaningful reversal of direction has occurred, which quite possibly was the case this week. On the NASDAQ there were more decliners than gainers, unlike the “Big Board” where there were more gainers. However, since the April 8th bottom, the NASDAQ Composite Index has led the US general stock market, gaining +51.92% compared to +37.02% for the S&P 500 and +28.72% for the DJIA.

 

The supporters of the political party that currently occupies leadership in both chambers and the White House cheer these recoveries but appear to ignore other data. For example, real private non-residential fixed income investments, excluding data centers, have been flat since 2020 and is far behind 2023 prices.

 

The Real Problem is Bad Debt Creation

For the “bulls” to be proven right, a large portion of the public’s uninvested money must be corralled to invest in the economy, in sufficient amounts necessary to generate the tax revenues required to support government spending and address the growth of the deficit. Instead, they are doing this by removing the Controller of the Currency and the leverage lending guidelines of the Federal Deposit Insurance Corporation (FDIC), which they felt were too restrictive. To add more fuel to risk capital they are encouraging retail investors to put some of their retirement income savings into private debt investments, even though there has been an increase in bankruptcies over the last four years.

 

Economic Tailwinds

Optimist believe the economy should have the wind at its back in 2026 due to the following positive events resulting from the “Big Beautiful Bill”. However, it remains to be seen whether these events translate into additional stock market gains or if these events are already reflected in current market prices. Some of these events could also be negatively impacted by Supreme Court decisions on tariffs.

• A relatively large number of taxpayers will see tax reductions in 2026, with some seeing tax refunds early in the year.
• Reduced regulations should decrease the cost of doing business and speed up the introduction of products to market.
• The reshoring commitment of over $18 trillion in manufacturing capacity should boost construction and the jobs required for that task.
• AI capacity construction should continue throughout most of 2026.
• Energy capacity construction will likely increase in 2026, with the introduction of small-scale nuclear power and construction of a new natural gas pipeline from Pennsylvania to New York.
• The House of Representatives passed a $900 billion military budget, which includes pay raises and an increase in defense spending. This bill still needs to go through the Senate before it becomes law. Some of these funds will be used to retool the military for modern warfare, which includes increased use of AI and unmanned vehicles.

Various underwriters are predicting that equity markets will generate double digit rates of return. On a long-term basis this is extremely difficult to do and can only be achieved by accepting the risk of periodic losses. By year end the year the S&P 500 Index could see its third consecutive year of annual gains exceeding 20%. Only once, from 1995-1998, has the market seen a 4-year period of consecutive annual gains of 20%.

 

Bottom line: Be Careful

 

 

 

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Mike Lipper's Blog: On The Way To Casualties & Eventually Riches - Weekly Blog # 918

Mike Lipper's Blog: Was it the week that wasn’t? - Weekly Blog # 917

Mike Lipper's Blog: Recession/Depression Risk Assumptions - Weekly Blog # 916

 

 

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On The Way To Casualties & Eventually Riches - Weekly Blog # 918

 

 

 

Mike Lipper’s Monday Morning Musings

 

On The Way To

Casualties & Eventually Riches

 

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

 

Current Situation

In the fog of the latest week there were a few possible clues of changes and pronouncements.

• In November, US manufacturing activity contracted for the 9th month.
• After Friday’s close, an emerging market fund rose +4.99%.
• The value of the US dollar has fallen -6.16% year-to-date.
• Financial Times headline: “Wall Street expects double digit gains next year”.
• Apollo provided a glossy wrapper to the weekend Wall Street Journal, titled “What if the old financial playbook is costing you?”
• The Trump boom is comparable to past expansions, but not yet as big a percentage gain of GDP as the railroad boom of the 1880s.

Each of these bullets point to possible clues for the future, which should be examined by long-term oriented investors and their managers, as this blog will attempt to do.

 

The search for Investment clues

• While we have become a service-oriented economy with high dependence on the skills and attitudes of workers, politicians focus more on the manufacturing sector which has more unions and workers paying real estate taxes and buying lots of local supplies. Thus, manufacturing jobs are more important in Washington than in NYC. I suspect the re-shoring of manufacturing will probably be more automated and will have less employees. Consequently, office holders need to worry about ’26 and ’28.
• The real purpose of announcing tariffs was to force meetings with economic leaders to reduce non-tariff trade barriers. This has led to numerous currencies dropping more than the US dollar. (In my view, this is the wrong way to create more prosperity. We should be raising interest rates, so we are able to absorb the likely increase in bad debts, particularly those held by private capital. Higher interest rates will also raise foreign exchange rates, encouraging foreign lands to utilize more of our exports. A richer world is safer and better for us than a poorer one.)  
• The “street” is predicting at least a 10% gain next year. This year the median US Diversified Mutual fund produced a year-to-date gain of +12.55% and an annualized gain of +10.12% for the five-year period, this is at least 2-3% better than the expected net income gain. The difference is the result of other income and stock buybacks. Currently, public polls suggest investors are not happy with the results.
• Bankruptcies are increasing, particularly in non-listed companies. Private capital raises money to invest in the equity of these companies or to buy parts of public companies. Some of the private-capital is sold to investors as an income producing asset, which often requires a periodic sale of some of their assets. In some cases, this has proven to be difficult because some of their holdings experience difficulties. (While there is some trading of assets between privates, the remaining assets need to be sold to listed companies. This may resemble the old game of musical chairs, where one or more of the ‘safe’ chairs are removed after each round. The remaining chairs will be purchased by the public market, so the private market is dependent on the public market in the end. My concern with regulators encouraging retail investors to put some of their retirement money in private vehicles is that they will be buying into troubled situations.)  
• The comparison of the “Trump Expansion” with the railroad expansion of the 1880s could be accurate. It was a period of speculative, and in some cases fraudulent activities. Many new issues came to market competing with existing firms, which led to price wars and consequent bankruptcies. The era ended when JP Morgan and others recognized that too much competition was ruinous, resulting in rigorous rounds of mergers. Much money was lost and many communities lost rail service.

 

Conclusion

We have entered a globally different world. Investors need to study carefully and invest for the long term, periodically choosing not to invest.

 

Thoughts?

 

 

 

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Mike Lipper's Blog: Was it the week that wasn’t? - Weekly Blog # 917

Mike Lipper's Blog: Recession/Depression Risk Assumptions - Weekly Blog # 916

Mike Lipper's Blog: Risks Are Rising Thru the Clouds - Weekly Blog # 915

 

 

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Dangers “Smart Money” & Thin Markets - Weekly Blog # 816

 

Mike Lipper’s Monday Morning Musings

Dangers “Smart Money” & Thin Markets

 

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

 

 

 

Christmas Breaks & Wishes

Like most weekly blog producers, I experienced an early December dilemma. Should I send out my seasonal best wishes to our readers and not produce the final December blog, or write it as usual? Not writing the blog was very tempting, but I then remembered George Washington’s very first military success in New Jersey. He and relatively small number of Patriots crossed the Delaware River and attacked the British (German Hessians) on Christmas Morning at Princeton.

 

My fear of a similar attack on our securities markets led to my decision to publish the blog. But to all our readers, I extend a very deep and heartfelt “Merry Christmas & Happy Holidays”

 

What Could Go Wrong?

1. I hope nothing.
2. The late December equity markets produced relatively light volume.
3. Below is a racetrack lesson on a not particularly distinguished bunch of horses registered for an unimportant race.

Late in the betting period there is a sudden surge in betting on a specific horse for no apparent reason. The chatter in the grandstand is that it was caused by external bookmakers balancing their betting exposure on a given horse. The presumption being that the clients of the bookmakers “knew” something that improved its probabilities. This surge was labeled “smart money” by those at the track. Sometimes, but not always, the chosen bet wins.

 

My fear is what market analysts call the distribution effect, because they understand what a third Obama White House doesn’t. That the initial absorber of sudden volume often tries to immediately offload as much of its liquidity volume on other players as possible. This secondary distribution can be repeated numerous times, enlarging the impact.

 

As happened during the last 2 hours on Wednesday, where all the major US stock indices fell significantly. Some observers pointed to a large trade, a series of large trades of a highly leveraged short-term derivative. By the end of the day individual securities were down multiple percentage points. Early Asian markets fell, but by the end of the trading day losses were small. On Thursday stocks rallied almost back to Wednesday’s opening and on Friday there was a slight gain.

 

This attack, like the one on the “British forces” at Princeton, did not have a material impact on the war other than to buoy up Washington’s spirits and please the Congress in Philadelphia.

 

I have no idea whether there will be other “smart money” surprises during the remainder of the year, but at least I am prepared.

 

Other Inputs Could Be Important

1. 58% of US households owned stocks in last 3 years, up from 53% previously. This included 21% from direct owners, up from 15% previously. (At some point this could have political implications). Only Estonia has a greater commitment to stocks.
2. All 3 major stock indices still have November price gaps.
3. Bankruptcies have risen to over 30% in the US and to over 25% in Germany.
4. Global deal flow is at a decade low.
5. PJIM forecasts sluggish growth for the next couple years.
6. FEDEX margins were materially down on a slight sales drop.
7. Many Wall Street bonuses were flat or up marginally.
8. The White House is considering an increase in Chinese tariffs, another pro-inflation move.
9. China announced new wide-ranging rules to reduce the number of on-line gaming hours. Not only did this wipe out $80 Billion in market value from the two largest Chinese game providers, but it also impacted other Chinese stocks and numerous stocks in other markets.
10. A picture is often worth more than a thousand words. The drawing room where the US President meets foreign leaders has 5 portraits of former presidents. The largest portrait is of FDR centered among the others. He appears crucial to the current President’s thinking. The similarities are pro-inflation, weak fighting forces, anti-business rules, higher taxes on the most productive, and isolationist policies. All of which turned a recession into a depression and encouraged our enemies. 

 

 

 

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Stock Markets Move on Expectations - Weekly Blog # 805

 

Mike Lipper’s Monday Morning Musings

Stock Markets Move on Expectations

Commodities Move on Transactions

Most Economics Relate to Needs

Politics Rotate on Vote Guesses

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

 

Variables

These are among the more significant variables that investors and the rest of society juggle in reaching investment decisions. Most investors focus their attention on only a few variables. Some use just one, like price charts or reported earnings.

 

Perhaps my lack of confidence in understanding the complete details of variables drives me to look for correlations, which is why I ponder many variables. This tends to result in the creation of diversified portfolios of funds and individual securities. Because my clients and I invest to meet a number of different needs, our investments are focused on several time periods.

 

With these thoughts as guidelines, I’ll share a number of factors I am concerned about that leave me worried. I expect the future to include numerous changes, with some coming as surprises. My portfolios are likely to be fully invested, with a willingness to shift elements when I become more convinced of the wisdom of future actions.

 

The tragedy in Israel is too new to take into proper perspective. Thus, I am excluding it from this blog, but not from my mind.

 

List of Worries (Not in rank order)

1. The number of small company bankruptcies is rising, along with general error rates. These are some of the critical connecting points in our society and likely to have larger repercussions.
2. The drop in food consumption at low-end retail outlets suggests budgets are getting stretched.
3. Jaime Dimon’s 100-year prediction of a 3 ½ day work week leaves too much time for troublemaking.
4. Those with advanced degrees have lost confidence in colleges/universities. Students graduating with degrees, including PhDs, have no job opportunities for their degrees. (All the nobility were blamed, and many executed during the French Revolution.)
5. A little more than half of mutual fund peer-group averages have generated losses over the last 3 years. (There is a risk of people refusing to invest.)
6. As developing nations mature, they attempt to import replacement of some of their imports, which reduces world trade.
7. UPS and FedEx often sell at discounts. (Deflation)
8. 75% of the items listed in the WSJ weekend prices declined (Deflation)
9. The S&P Goldman Sachs Commodity Index rose +4% in September. Due to dollar strength, Energy and Metals rose +3.5%, with Agriculture falling -4.35%. There may be some speculative input in these numbers.

 

Critical Questions:

1. What are the indicators you are watching?
2. What do you think?
3. Will you share your thoughts?                                                                          

 

 

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Fire Drill - Weekly Blog # 782

 

Mike Lipper’s Monday Morning Musings

Fire Drill:

On board ships and in schools, why not in investing?

 

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

 

 

 

Any Smoke?

Implications: US stock index returns are almost normal for the full year if we use the year-to-date performance of the Dow Jones Industrial Average +7.16% and the S&P 500 +8.14%. Even the NASDAQ +18.64% is representative of a good speculative year, perhaps benefitting from short covering. The VIX indicator is almost asleep at 15.76, compared to 30 in past mildly troubling times.

 

There are some whiffs of smoke in the air, including a continuing 2 to 10-year yield inversion spread of 4.08% - 3.45%. Updating one of the oldest technical indicators with a more modern twist. In the latest week the 30-stock DJIA had 20 stocks rising to 10 declining, but the 20 transports split 6/14. (In the original Dow Theory, it was only the rails in the index. Today the number of rails has dropped, and a number of airlines, trucks, and other transportation securities have been added.) This could be significant if the normal buyers of rails, which are freight driven, are looking for future declines. 

Another group that appears to be worried are the CEOs of traditional financial services companies. The latest to announce a 10% layoff from both their investment banking and investment management functions was Lazard. (Mid-market M&A industry revenues hit a 9-year low in the first quarter.)

 

Publishers Note

The popular distinction between a recession and a depression is your neighbor losing his job in a recession and you losing yours in a depression. It can be helpful to explore the possible roads to a depression by focusing on the needs of securities analysts regarding layoffs. In focusing on the way companies handle layoffs, they should first be aware of the lost art of making money from bankruptcies. All too often layoffs are the first act of self-inflicted worsening conditions. Since they don’t teach about surviving bankruptcies today, they are unequipped to adequately analyze layoffs. (I admit the thought came to me in a recent meeting with the Dean of an upcoming Business School, where there are no classes on bankruptcies.) 

While a Columbia College undergraduate I was privileged to take Securities Analysis from Professor David Dodd, who was both an academic and investment partner with Benjamin Graham. David Dodd collaborated in producing the seminal work on Securities Analysis based on their experiences in the 1920s and 30s. It occurred to me that the whole basis for the course was the knowledge necessary for those who’d lived through the depression. This knowledge could be important in the coming era, and I will consequently devote the rest of this blog to the types of things one should look for prior to and during such a period.

 

The Fixed Income World is Different

There are two critical differences between fixed income and equity.

1. The first is the legal relationship. Fixed income is a contractual relationship with an initial investment, periodic payments, maturity, and rank in the order of payments in a bankruptcy.
2. Owners of fixed income securities are expected to be paid a pre-determined amount of interest and pre-payments of principal, as well as a final payment.

If payments are not delivered as promised, the default process is governed by the issuing documents. Things change dramatically when a bankruptcy begins. All debts immediately come due, sourced from the potential sale of all assets. Debts are paid in priority order, as specified in the issuing documents.

 

However, compromises are often made to get agreement from the holders of different classes of claims. This helps expedite payments rather than having to endure long, expensive court hearings. The size of the payments is a function of the price paid for the assets, less the costs of the sale. The cost of the sale includes the cost of highly specialized attorneys, accountants, and other experts.

 

Fixed income securities rights and privileges are senior to common stock rights. Owners of common stock will probably be wiped out, as there is generally no additional money to pay out after the senior debt holders have been paid. However, to avoid long and expensive court battles by equity owners, they will often be awarded a small amount of a subsequent new equity class.

 

What is a Bankruptcy Worth

Up to this time the focus has been on the current appraised value, usually in a quick liquidation. To the extent there is a belief that a “going concern” will survive bankruptcy, a different kind of analysis is needed based on the current use of the assets and their user in the future.

 

Growing up in Manhattan there were neighborhood cigar stores on many commercial street corners. They were good business in the late 1920s and became less good as time went on. By the early 1940s those businesses had effectively died. A chain of these went bankrupt, but their stock went up in price!!! The reason for this was that these stores were on busy corners and had long-term leases. A classic case of being worth more dead than alive.

 

There were a couple of cases of railroads who lost lots of money throughout the depression and went bankrupt. However, a couple of sharp investors saw a similar situation, as the railroads had considerable land along their right-of-way. In the WWII expansion of plants and military camps, these lands and their proximity to the rails became very valuable.

 

The unfortunate attitude of too many of today’s analysts and portfolio managers is that “value” is found on the published financial statements. To them, stock selling at a discount to book value is a bargain. In truth, book value is a collection of unamortized assets not written off. Because of changes in the market for a company’s products, the use of their facilities is less than their original purpose. For example, strip shopping malls in poor locations today.

 

What is not reflected in the financial reports are the developed new products, self-generated patents, a good sales force, key employees, etc. These are the types of assets we look for as investments.

 

The items mentioned in the last paragraph are critical in evaluating various layoffs. To the extent the layoff managers husband these types of assets I am not concerned, but if they are shedding valuable assets I am.

 

 

How Do You Evaluate Layoffs of Owned Stocks?

 

 

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Deeper Thoughts - Weekly Blog # 715

 

Mike Lipper’s Monday Morning Musings

Deeper Thoughts

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

Governments Manipulate Markets More Than Markets Manipulate Governments

Warning: Some of your basic beliefs will be challenged by the following analysis. Accept what you will. The value of this blog is the path of analysis, which may cause you to think differently about some matters.

Finally, a Wake-Up Call

In the first trading week of 2022, the US stock market experienced an unexpected downdraft on relatively light volume. Normally, the first week of the year is one when pension funds and other retirement accounts (401k) make their annual commitments to equities, usually giving the market an upward bias. Why not this year? Two possible clues emanate from the yield on 10-Year US Treasuries and NASDAQ Composite prices. They both often lead US markets in direction, which in turn tends to lead most global markets.

While the New York Stock Exchange (NYSE) experienced more up volume in 4 of 5 days, the NASDAQ experienced more downside volume in 3 of 5 days. The NYSE up volume may result from the annual commitment of retirement accounts. The NASDAQ’s higher percentage of new lows, 16.4% vs 7.6%, uncovers some disturbing results. About 20% of NASDAQ stocks have fallen into “bear market” patterns. (As regular subscribers know, I use the NASDAQ price performance as a leading indicator, partially due to the relative absence of passive investors in that market. While I have no data to support my view, NASDAQ investors hold their positions for shorter periods due to more buyouts and bankruptcies.)

From a broader perspective, the rise in 10-Year Treasury yields to 1.77% may be even more significant. Over the weekend, the Bloomberg news crawl indicated European investors being shook by the drop in US Treasury prices. I believe this was mostly the concern of European central banks, excluding the Swiss National Bank. (The SNB has been investing in US stocks to cover the pain caused by the rising value of the Swiss Franc. Their largest position is a meaningful investment in Apple *.) The play in UST paper, until this week, has been the strength of the dollar. Even when hedged, its net yield was better than most other government debt. I believe many European accounts needing dollar debt have gravitated to non-government bonds.

(*) Owned in personal accounts

The decline in US government paper was long overdue. While probably still the safest large currency, the credibility of this Administration’s word is a growing concern. s Most rational global investors were shaken by the way the US retreated from Afghanistan, leaving many people promised entry into the US stranded. Currently, our use of words rather than military force to protect the people of Ukraine downgrades belief in the US. The Administration’s Anti-Trust efforts to buy union votes at the expense of commercial capital is also a worry. 

Almost All to Blame for Growing High Inflation

For political reasons, many governments look to solve social problems through central control. Led by politicians with no real-world experience they utilize top-down thinking. This is called socializing the problem, which requires money from the “well-off” to keep the unfortunate barely above water. Charity has been part of the world since the organization of religions. One biblical view is that it is far better to teach someone to fish (profitably), than to feed them fish. If governments truly wanted to help, they could arrange tax structures to encourage charity, with some constraints on charitable organizations.

Instead, today’s political leaders follow the ancient Roman political practice of providing bread and circuses (games) to keep the lower classes quiet. Over time, the costs of this strategy led to raising taxes. High taxes took money out of the commercial economy and led to underspending on military and other vital services. These choices led to a weakened state that was overrun by The Barbarians. Almost every global empire has fallen due to a similar pattern of political leadership, high taxes and a weak military.

There are two ways of reducing financial wealth, taxes and devaluation through inflation. The Romans did it by reducing the amount of gold and silver in their coinage, we are doing it through higher prices. Milton Friedman stated, “inflation is always and everywhere a monetary phenomenon”. Inflation accelerates with a shortage of critical goods and services. Many governments pay lip service to solving society’s ills by borrowing today and repaying later, in money devalued by inflation. Both the current and prior Administrations have practiced this policy. 

The financial history of Donald Trump was massive borrowing with debt often settled at below face value. By the time Trump built his Casinos in Atlantic City, he was already running out of sources of credit, which led him to depend on Deutsch Bank. (As some of his debt was publicly traded, an analyst in a Philadelphia brokerage firm wrote a report questioning the soundness of the debt. Trump tried to get the analyst fired using his bully tactics but luckily, he was not successful. His major Casino went bankrupt and its debt trades at junk prices today. As President, he grew the size of our National Debt with the clear intention of buying it back at below face value.

The current Administration seeks to increase its union workers voter support, mostly in Northern states. The party in power is simultaneously trying to reduce the economic power of other states through taxes, tariffs, contracts, and anti-trust policies. They hope people will not see the devaluation of their hard-earned money in the financial press, although they will see higher prices at the grocery store. Much of the inflation results from the cost of transportation of goods and services, with the price of oil rising from below $20 to about $80 a barrel. This was caused by closing pipelines, preventing drilling on federal lands, and other such measures. Consequently, the US is no longer energy-independent and relies on expensive foreign oil being shipped into the US.

Six Day Tally

I don’t know what future prices and fund net asset values will be. However, the dichotomy in results through Thursday is cause for concern. These results exclude a further significant decline on Friday. The following list of comparisons may be of interest to those trying to make sense of the US stock market:

1. The JOC-ECRI Industrial Price Index performance year over year is +32.15%.
2. The AAII sample survey summary predicts no direction, with bullish, bearish, and neutral all about 33%.
3. The Barron’s Confidence Index projection of future performance shot way up, favoring bonds over stocks.
4. 2/3rds of weekly WSJ prices for stocks, bonds, ETFs, currencies, and commodities fell.
5. While the NASDAQ declined -4.53%, S&P Small-Caps only fell -1.23%.
6. The average Value fund rose +0.98%, while the average Growth fund fell -3.65%.
7. Only 2 of 31 fixed income fund peer averages rose.
8. Only 1 of the 25 largest equity funds rose. 
9. In December, 8 of 11 equally weighted S&P sectors beat the capital weighted indices. Only 10 of 50 S&P global indices gained 20% or more in 2021.

This suggests to me that 2022 is going to be a difficult year. 

What do you think?

  

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https://mikelipper.blogspot.com/2022/01/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/12/are-investors-taking-too-much.html

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Different Forts: Misconceptions on Risk-less Investing + 3 Reasons for Equity Mutual Fund Redemptions - Weekly Blog # 497

Introduction

Attorneys in court often arrange “the facts” to support a conclusion. Economists and Professors of Finance suffer from “physics envy” of immutable laws. Politicians and pundits speak in sound bites. Investors, like other good judges, look at all of the information found in hard and soft data. Most importantly, investors should avoid accepting any proposition on the face of what is presented. Wise investors have learned to probe for a more complete understanding of what is on offer. 

Is Risk a Number?

Pity the poor professor introducing investments to a class. He or she finds it easy to introduce the concept of gains. It is essentially one of addition or in some cases multiplication. The problem is to introduce the concept of losing which is similar to subtraction. The real issue is to come up with a way to measure potential rewards vs. potential losses to get to a conclusion as to the risk of an investment. In the search for a mathematical answer rather than a deeper understanding of the different kinds of risks facing different investors, academia came up with the movements of US Treasury bond prices.  They measure the price pattern of the desired investment versus the volatility of Treasury prices. Thus, the idea of a “risk-less” rate of return was born. Investment sales forces deducted this so-called risk-less rate from the actual performance of a stock (and more frequently a fund or other portfolio) to create a comparison of favored investments, adjusting for risk.

While it is true that often the movement of treasury prices captures a reasonable amount of the general volatility in the stock market, for investors risk is the penalty for being wrong that causes changes in spending plans. It is these risks that cause pain to investors and their beneficiaries plus create “career risk” for hired professionals.

The use of Treasury prices presumes that there is no fundamental changes in the future of the Treasury market. Because of the changing market structure I believe that there will be periodic changes in the Treasury markets. In this weekend’s Financial Times John Authers has a column that is headed “Liquidity looms as the real challenge facing new Fed Chair Powell.” While he doesn’t spell out the problem, it is clear in the future he is properly worried that the various central banks led by the Federal Reserve will be cutting off credit through the banks to the fixed income market. While the Dodd Frank Act curtailed the commercial banks and large investment banks in their market-making efforts in securities, it did not really address the banks’ extension of credit to the few remaining market-makers. These credits are much larger than the banks’ own securities positions. There is already a shortage of repurchase agreements or repos at present. One sign of structural disequilibrium is that for ten year Government bonds, the US is paying 100 basis points more than the UK pays for its bonds and 200 basis points more than the German bonds. This suggests that the US paper is worth more. Why? I believe the reason is that it is the best collateral for loans that support borrowings for the purchase of derivatives and currencies which can be extremely volatile. Since most loans are immediately callable, there is the sort of risk that started the problems that led to the 1987 and Lehman crises.

  

Thus the ownership of a 4% yielding common stock or fund with a payout ratio of 40% or less and a price/earnings growth rate in the single digits versus a holding in US treasuries may be more dangerous in terms of risk to the investor and career risk to the professional. But these are unconventional thoughts.

Investors Rejecting Equity Mutual Funds

The constant drumbeat that retail investors are deserting mutual funds in favor of ETFs needs much deeper analysis than the pundits are giving it. For a number of months industry headlines have been screaming about the net redemptions of equity funds and this week is no different. Except they are missing the motivation behind the redemptions and its significance. The largest amount of redemptions is coming out of the Large Cap Growth funds. I do not believe that it is performance-related. On a year to date basis through November 2^nd,  my former firm, Lipper Inc., reports that Large Cap Growth funds, on average, have gained 26.03%.  No other non-leveraged, General Equity fund category has done as well this year or even in the last five years. The only other domestic funds that have done better are the Science & Tech funds. Some International funds have done better in part due to foreign exchange considerations.

Why are there so many redemptions?  There are three answers. The first is simple, the second is structural and the third has to do with the changes in the brokerage market.

The simple answer is that the Large Cap Growth funds have more assets than any other investment objective. Thus, logically over time it will have more redemptions. 

The structural answer is that investors put money into funds to meet future needs. The very day that someone invests in a fund, a future redemption is set up in the indefinite future. Because of the way many estates are settled, usually liquid investments are sold to distribute as much cash as quickly as possible so funds are not often directly inherited.

The third cause of redemptions relates to the fact that a large portion of investors in mutual funds was sold by commissioned-paid brokers. At the time of many of these transactions the commissions of mutual fund sales were among the highest rewards to the sales force. Currently many of these salespeople have morphed either into registered investment advisors or have changed firms for understandable reasons. In their new shops they are no longer motivated by commission sales but by investment advisory fees. As their books of business mature, there is little attempt to replace stock mutual funds in their aging accounts. These investors are converting their investments into either fixed income funds (whose sales are booming in spite of the likelihood of higher interest rates/lower bond prices), or into Exchange Traded Funds. In the latter case the investment adviser will charge an annual fee that within a few years will more than compensate for the loss of mutual funds sales commissions.

Hints For the Future

At some point before the current market suffers a major decline, there will be a more general recognition as to the risks in the fixed income market with higher yields driving fixed income prices down. The credit cycle in high quality paper will contract. It is likely that we may be surprised by the levels of domestic and international bankruptcies which won’t be isolated events.

On the equity side grudgingly we are seeing enthusiasm growing. In the last two weeks sentiment has become more bullish as measured by the American Association of Individual Investors (AAII). It will have to be sustained for a considerable period of time to fulfill a bear market indicator. In addition to Large Cap Growth funds and stocks doing well, industrial metals commodity prices are also ahead, showing a year to date gain of 25.11%. One of my senior analyst friends describes his current portfolio as a 1950s one. As many of the relatively newly minted investment advisors don’t have the historic perspective for the type of market we appear to be entering, they will disappoint some of their customers leading to a positive surge in equity mutual fund sales. (As an owner of a number of domestic and international mutual fund management company stocks both in my private financial services fund and personally, I hope so.)

Question of the Week:

For your own account how are you defining risk?  

__________

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