For Better Performance: Pick the Right Data - Weekly Blog # 960

 

 

 

Mike Lipper’s Monday Morning Musings

 

For Better Performance: Pick the Right Data

 

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

            

 

 

Kevin Warsh Right in the Beginning

One of the first substantive moves made by the new Chairman of the Federal Reserve Board was recognizing that the Fed has historically focused on the wrong data to predict the future movement of interest rates. Our fraternity of market followers and predictors (analysts and portfolio managers) have enshrined various indices as guideposts to the future. Unfortunately, both the Fed and “The Street” have used the same or similar indices, which largely rely on Federal Government produced data. Chairman Warsh recognized these indices were not particularly useful and feels it’s time to consider adding other data points, both for the Fed and “The Street”.

 

For probably three generations, the amount of money devoted to the gathering of economic activity has been declining on an inflation adjusted basis. The decline was accelerated by the current administration through the brief Doge period by paying a premium for retirement in various agencies. Much of the data was gathered by low-income people in various companies, which led to late filings and inaccuracies.

 

What Would Be Better

Since the beginning of time market followers have looked at what people bought in the way of goods & services and how they invested their money. Many of these approaches are still useful today to get a feel for the temperature of supply and demand and to see how investments and savings are taking place. I find this approach useful in determining the probability of future price movements.

 

These Are the Items I am Following

• What are companies currently doing that is uncharacteristic of what they did in the past. In the latest edition of Barron’s there is a brief article on three stocks we own for ourselves and clients: Berkshire Hathaway, Apple, and Walmart. (These are not recommendations, which should only be made with an understanding of the investor’s knowledge, experience, other securities held, and perceived needs.) Each of these companies is doing something new for them. Berkshire Hathaway is growing a collection of companies building housing communities at different price levels. Services provided by this collection of companies includes mortgage generation, real estate brokerage, and possibly a supplier of public utilities. (They have not announced an overall plan, but it is interesting that they are putting together this effort at a time when the housing market is depressed.)
• Apple’s new CEO is likely to produce new products & services, akin to what Steve Jobs did. While these new items may share some of the characteristics of existing products, they are likely to open new markets for Apple.
• Walmart is exploring the use of its communication relationship with grocery customers through paid advertising. Grocery customers are Walmart’s largest source of sales and this could lead to the largest and possibly its most profitable electronic advertising network.

 

Not all these new ventures will work, but the analytical key is examining the radically new ventures smart companies are undertaking.

• The bond market in terms of timing is ahead of the stock market. Most of this year the volatility of bonds has been greater than stocks. The bond market is structured around credit conditions and the central government is theoretically deemed to be the best credit. This is true most of the time as judged by those outside of its control, with its price relative to other currencies fluctuating on perceived inflation rate concerns. The US dollar has declined in purchasing power due to inflation, as have most foreign currencies. One measure of purchasing power is the price of gold, which in our lifetime has risen from its fixed price of $35 an ounce to today’s level of $4320.50. (Remember, prices can go up as well down. On January 1st, 1980 gold sold for $850 an ounce and by June 1982 it had fallen to $300.) Gold is nevertheless a good indicator of what the market believes the future price will be. For the 5 years ended last Thursday, the average gold fund gained +25.29% per annum compared to +17.52% for the average global natural resource fund and +10.37% for the average commodities’ fund. (If inflation drops to 2% or lower, the price of gold would be expected to drop materially). This could happen sooner than the market expects considering 61% of the 72 weekly prices The Wall Street Journal reports were down for the week.
• Chicken dinners are growing and beef meals are dropping at restaurants from McDonalds to high-priced dining locations.  Furthermore, the number of people in restaurants are declining, while some are closing.
• Investors sense that change is underway. In one collection of equity accounts investments have fallen by 3.5% since early September, while news from Washington remains positive. Psycho analysts tell us that people feel losses twice as much as they do gains. With me it is more like 3+%.
• We are seeing the number of people working in the financial community shrinking, and not all of it is due to “AI”.

 

Chairman Warsh Commented

Warsh awaits the reports from his five investigative committees due by year-end. He has noted that instead of the Fed paying attention to annual data, he sees change in periods as short as 3 months influencing future actions.

 

As usual I seek your comments so I can learn.    

 

 

 

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Mike Lipper's Blog: Are We Refighting the American Revolution? - Weekly Blog # 959

Mike Lipper's Blog: Survival First, Before Growth - Weekly Blog # 958

Mike Lipper's Blog: Are We in Normal or Historic Times? - Weekly Blog # 957

 

 

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Caution Ahead: Emotional Turns Likely - Elections and Coronavirus - Weekly Blog # 644

 

Mike Lipper’s Monday Morning Musings

Caution Ahead:

Emotional Turns Likely-Elections and Coronavirus

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

When the battlefield is quiet, expect to be attacked, is a lesson from the US Marine Corps. For bullish equity investors the low volume of August trading should signal a need to expect change. The most dangerous short-term change is one spurred on by emotions, rapidly bringing into action holders of excess cash or large equity holdings.

The calendar provides two events that could quickly galvanize emotional responses, the forthcoming US election and reports of successful vaccines/therapeutic COVID-19 treatments. Both could mobilize a large amount of almost instant trading from thrilled and disappointed investors. Based on a lifelong study of turning points, I suggest caution on the part of investors who believe in rusty or non-existent trading skills. Furthermore, very soon after the announcement a counter trend could appear, reducing the size of the initial pop and in some cases completely reversing it. As more information becomes available, the implications of the announced event will often become clearer. Even if further information reinforces the initial announcement, the length of time varies before complete utilization becomes evident. Thus, investors will have time to calmly adjust their holdings. 

Profitable courses of action build on some factors present before the headline event, while others will have little to no future impact. Some will advise you of the critical present factors supporting the future event, I am not so privileged. All I can do is briefly list some of the factors that might support the trends post the announcement, including the subsequent reversal moves:

• The biggest investment news of the week was the changing of the components of the Dow Jones Industrial Average (DJIA) and the reweighting of Apple*. The current producer of this most senior of US stock indices is S&P Indices, owned by Standard & Poor’s, who consults with some of the editors of The Wall Street Journal when making changes. On Monday they will delete Exxon Mobil, Pfizer, and Raytheon Technology, adding Sales Force, AMGEN, and Honeywell. In addition, on the same day the weight of Apple in the index will be reduced due to Apple’s four for one stock split. It will be replaced as the company with the heaviest weight in the index by United Health.

Because of the dominance of Dow Jones through its wires and publications, most investors tend to believe that the DJIA measures the US stock market. That a thirty-stock market price weighted index is “the market” with its’ 30 stocks and not the S&P 500, the Russell 3000 or the Wilshire, with its original 5000 stocks, shows the power of the media. Clearly, global indices have even more components. Nevertheless, the DJIA has done a reasonable job of tracking high-priced US stocks. Part of its success is due to dropping components when their outlook appears to be slowing. (Some components comeback into the index after a large merger.)

While most market followers will continue to use the DJIA as a market measure, I will not for the next twelve months. While statisticians will link the new components and the reduced weight of Apple, I believe they have created a new measure. After one year I will see the level of correlation with the S&P 500 and if the gap is close, I will return to using it as a measure. Once again, the editors may have done a good job of changing the components to represent our economy. Over the more than one hundred years of its existence, they have done a good job of switching the emphasis from consumer products, to industrials, to tech and then to high-tech.

(*) Owned in personal accounts

• Record high prices achieved this week for both the S&P 500 and the NASDAQ Composite confirms the view that the American Association of Individual Investors (AAII) sample survey of market direction for the next six months is a contrarian  indicator. For the first time in many weeks the leading bearish prediction fell below an extreme reading of 40%. 
• 79% of the WSJ’s weekly prices rose. This may reflect some shortages, but it also reflects merchants trying to increase prices to make up for forgone profits. Despite many learned economists being quite sanguine on inflation, I expect the Fed to get and exceed its desired 2% inflation target.
• Unfortunately, I expect layoffs will rise for a while. The Russell 2000’s second quarter estimated revenues dropped -19%, with earnings dropping -99.1 %. This indicates to me that smaller companies have kept their staffs to preserve their hard to get employees. So far, third quarter revenues have not risen much. There is a good chance that instead of preserving the work force the focus will shift to preserving the firm. I suspect private firm closings indicate a similar trend.
• The bond market is moving contrary to the stock market. Of thirty-one fixed income mutual funds investment objectives, only twelve gained for the week and they were equity tinged high-yield or pro inflation vehicles. The maturity yield curve tightened, with maturities of more than two years rising.
• There may be more longevity to the current market than appears. Typically, markets don’t peak until they exhaust all available cash and there is a lot of cash on the sidelines today. In addition, there is a lot of capacity to increase margin borrowing.  Remember, margin can be used to support short sales, as well as the more popular long purchases.

Working Conclusions:

• Trading oriented accounts should be prepared to make lots of small moves and be willing to reverse direction when appropriate.
• Capital appreciation accounts should look for bargains by being contrary.
• Capital preservation accounts need to recast their portfolio in one or more other currencies to determine their risk of only evaluating their accounts in dollars. European investments may look attractive for “value” oriented accounts and Asian investments could be attractive for long-term growth investors. Multi-generational investors should develop an understanding of the long-term outlook for selected investments in Africa and the Middle East.

Share your reactions and thoughts with us. 

     

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https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings_23.html

https://mikelipper.blogspot.com/2020/08/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/08/rotating-leadership-likely-on-horizon.html

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SEARCHING FOR A BOTTOM AND A PLAN - Weekly Blog # 619

Mike Lipper’s Monday Morning Musings

SEARCHING FOR A BOTTOM AND A PLAN

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

Where Are We?
It has been about ten trading days since a large gap developed in the popular US stock market indices. Market analysts believe two things about gaps.

• First, most of the time gaps must be filled before the trend can continue. Less often, there is a belief and sudden realization that something important has happened, contrary to what had previously been believed. 
• Second, and perhaps more significantly, China managed to shift gears and become less trade oriented just as the earnings outlook for 2020 turned more modest, with much of Europe approaching “stall” speed in the first quarter. 

In late February, largely non-coastal investors with drivers licenses for ten years or more, had what could be called a “red scare”. They feared there could be a radical change in government that would put into question both their taxes and the long-term health of the economy, including their investments. At the same time an increasing number of investors became conscious that the “workshop to the world” and a big customer was dealing with a new fear labeled COVID-19. After substantial stock market gains in 2019, it appeared wise to take a foot off the investment peddle and wait for future developments.

What Happens on a Gap Day?
These are the Friday, March 6th stock price changes, a Gap day for the Dow Jones Industrial Average (DJIA) and a single high grade financial services stock we follow:

                                          Financial 
Occurrence                        DJIA  Services Stock
Friday Opening vs Thursday Close -2.54%     -4.29%
High for Day vs Thursday Close   -0.48%     -2.98%
Low for Day vs Thursday Close    -3.43%     -6.58%
Close for Day vs Thursday Close  -0.98%     -4.31%
Close for Day vs Friday Open     +1.60%     -0.03%

If you just compared the closing prices of the two days, one might conclude a continuation of the prior down days. However, if you compare the close with the opening, you might think the downward pressure on the stock was spent. Turnaround days are frequently challenged by another down day, which either holds at current prices or finishes higher or lower and is then followed by a price rise. This is in effect the first day of the end of lower lows, at least for a while. Let’s hope so.

Any Evidence of a Fundamental Turn?
Remember, almost any study of past market cycles indicates that the market senses change before new events happen. Both periods before World War I and II showed that markets sensed forthcoming problems. At other times markets have started to rise before the news events that followed.  There are at least two current observations that point to an upward market.

While stocks can get favorable surprises, bonds and other credits rarely do. Interest rates are a driver of fixed income markets and are therefore tracked carefully. As a stock analyst I pay attention to the bond market as a forecasting tool. As with many tools, you need to carefully separate those becoming popular vs. those the smart practitioners are using. While an increasing amount of money is being poured into fixed income markets and funds, it has the feel of the Children’s crusade in the Middle Ages, which resulted in them being slaughtered. The current shrinking level of interest rates will clearly not fully pay for the increasing needs of the future.

Looking at the current interest rate table, while the front end is dropping, yields for maturities of five years and longer are going up (fixed income prices are falling). Each week Barron’s tracks an index of what it labels “Best Grade Bonds”, as well as another index made up of intermediate grade bonds. This week the yields of the best grade bonds declined by 30 basis points compared to the intermediate credits, which declined by only 13 basis points. Translated into non-market talk, high quality bond prices went up more than twice as much as the yield hogging intermediate crowd. This suggests that the big money feels the need for better quality. With common stocks yielding more than bonds, one would think that money would come back into the stock market at some point in the future.

Addressing the fears being generated by COVID-19. I find it encouraging that funds invested in India were the worst performing group this week, while three funds invested in China were among the top twenty five performers, indicating a brightening picture in China. Apple expects its factories in China will be operating at their prior levels by the end of the month.

The Plan
During each bull market a group of mid-level Wall Street executives, either formally or informally, created a Planning Group which disappears during the next recession as members find new and better income producing jobs. This demonstrates that during the bull market there was a group thinking beyond the next accounting period. I participated in some of the discussions, as it was useful to increase my knowledge of how “The Street” thought about the present always being difficult and the future always being better. I saw the benefit of organizing one’s thinking about the future and the futility of planning. With those thoughts in mind I suggest we are in some form of interregnum, where it could be useful to ponder the future. The next section is therefore an exercise in thinking about the future, providing a platform to disagree and aid your thinking.

Coaches and Racetrack Handicappers Deal with the Future Now
All winning or losing streaks are relatively rare. Normally, life rotates between wins and losses. Every professional coach needs to both assure his/her players that the immediate past does not dictate the next event, and more importantly the lessons that should have been learned.

As you can’t speak to the horses and can only communicate with jockeys and trainers, bettors often throw the past race or races out. I therefore suggest we throw out not only the first quarter of ’20, but be prepared to extend the discard pile to at least the first half and possibly all of the year. The recovery from the virus and a difficult election cycle will only distract us. It will not be particularly significant to our investing in ’21 and beyond. Here are the following lessons:

1. We live in a world of interconnected surprises. One needs to be alert and see them both as an opportunity and a threat.
2. Periods of expansion almost always lead to an over extension, which stretches resources beyond their capacity.
3. Crisis Management all too often starts after the crisis is already well on its way.
4. Physical, mental, and emotional health are critical assets that are potentially at risk at all times.
5. The ability to recover and correct is the sign of a champion in sports, business, and relationships.

Planning Elements
The following are considerations in building a sound plan:

1. Assess the need for money within calendar year periods, e.g. 2021-2025, 2026-2035, Beyond 2035.
2. Within each of the years, one should list the needs in terms of importance.
3. Assume a minimum of a two year down market that could stretch to four years.
4. Review your current portfolio and separate out those investments that are fulfilling their desired or at least expected results. Reduce by at least half those investments that are not working.  As we are going into a recession no later than 2022, the limit in aggregate “turnarounds” should be 10% of the portfolio or better (10% of the risk portfolio.)
5. Begin building your shopping list for future investments and slowly buy a minimum position to get the reports and begin to understand how they trade.
6. As many around you become more pessimistic and follow the market’s fall, begin building the foundation for the next investment cycle.
7. Attempt to spot strong elements of excessive ego in both yourself and the senior management of your investments. Reduce their position levels to recycle money for the next expansion. Allow for some mistakes, as we all make them and must recover and move on.

Question of the week: Are you thinking about the next investment cycle? 



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2020/03/should-changes-in-markets-change-your.html

https://mikelipper.blogspot.com/2020/02/hate-doesnt-work-for-investors-weekly.html

https://mikelipper.blogspot.com/2020/02/investment-losses-can-be-prots-weekly.html



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Extreme Popularity Creates Risk - Weekly Blog # 541

Mike Lipper’s Monday Morning Musings

Extreme Popularity Creates Risk

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

Risk from Other Owners
Too many investors focus their analysis on the risks to the issuer of their securities, as well as external factors like the political economy. The big lesson learned from major price declines is that the single biggest risk comes from the other owners in the securities. When it comes time to sell in a period of high anxiety, the other owners become competitors until the exit is completed. That is the missing lesson from the series of articles on the price collapse in sub-prime mortgages, Long Term Capital Management, Lehman Brothers, and the Reserve Fund. In each case the specific liquidity problem of the issuers triggered a market liquidity crisis for other securities and markets.

The history of big crises is captured in those three letters =big. Due to the popularity of investing in a security or type of security which absorbs liquidity on the way up, there is often insufficient capital to provide liquidity on actual or rumored mass exits. In other words, at the point of contemplated or actual exiting, there are few to no buyers left.

Could we be approaching such a situation in the credit market? Will it stampede the corporate bond market and possibly the stock market? Will the stampede include some bank capital positions? Maybe.

When? Now or Soon?
Timing is the most difficult tool in the investing art form. As with our favorite portfolio strategy of sub dividing a portfolio into separate time spans, there are three different approaches depending on time spans. Randall Forsyth in Barron’s stated “Since 1950, September has been the worst month of the year for the Dow and the S&P 500”. That is the immediate worry period.

The great economist Hyman Minsky identified that periods of stability bread instability. This makes sense, as far too many investors take current conditions and extrapolate them into the indefinite future. That is a lazy way of thinking. Change occurs every day, most of it small, but the increments add up leading to an unrecognized reality, until there is a shock of some sort. Investment committees and wealth managers are particularly susceptible because they are planning finite periodic distributions.

The longer-term change is a slow recognition of a faulty set of assumptions. There is one visible today, utilizing mutual fund performance data from my old firm Lipper, Inc, presently a part of Thomson Reuters. For the last five years there have been two trends that  cannot continue forever and have been contrary to investors best interest. For the last five years through August 30th, the average US Domestic Long-Term Fixed Income Fund has grown at the rate of +2.55% per annum, in contrast to the average US Diversified Equity Fund which has grown +11.11%. During the same period there has been a net flow into bond funds and a net redemption in equity funds. The biggest net redeeming group has been Large-Cap Growth Funds, which gained +15.78%. Possibly, those that guide investors will wake up during the next decline and sell out of their fixed income funds, which presumably will go down less than the stock funds, and recommit their assets to stock funds. (Some may overcome the relative pleasure of losing less, but most won’t until much later.) Even in executing this maneuver, they will probably still be behind most stock fund investors who stayed through the period.

The Two Biggest Risks
The first is that we have moved from a pattern based on business cycles to one based on capital cycles. Almost all activities used in inflation defenses have become directly or indirectly leveraged by the use of borrowed money or float. The financial community, in order to supply the necessary funding to make the system work, has moved from sole reliance on stocks and bonds to rapidly expanding the use of credit instruments. Most brokerage firms and other investment organizations have entered the credit markets as packagers and sellers. The competition to become the dealer in the paper has become intense and has led to weaker covenant constraints in the underwritten bond market. Many of these instruments are traded in private markets, with little public price discovery. These are conditions that could well be a ticking time bomb under the whole financial market. There will be actual or rumored defaults on these instruments.

As with the current concern for contagion in Emerging Market bonds, stocks, and currencies, it may be time for similar fears in the credit markets. The contagion risk is not primarily in the instruments themselves, but in the capital structures of both the leveraged holders and the market makers. When a holder of damaged or defaulted paper recognizes the problem, its immediate need is to restore its capital cushion. Typically, the way they do this is by selling their most liquid holdings to raise as much cash as quickly as possible. A sudden and desperate need for capital in one market often flows into other markets. Thus, it is possible a credit market problem can cause disruption to the bond market, which in turn can affect the stock market. Remember, most of the time investors and traders value their holdings relative to other securities. If the other securities are weak it impacts the value of their securities.

The second big risk, and this is over considerable time, is the cost to the ultimate beneficiaries of our wealth, which in times of stress may withdraw from the combat of investing. Cash becomes too comfortable and low-price opportunities are missed, sacrificing future earnings growth. These losses are much larger than the temporary losses resulting from riding sound investments down before they revive.

FORWARNED IS FOREARMED
 
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Fixed Income Risk Hurts Alternative Funds

Introduction

Debt and equity are the two essential building blocks for all portfolios. With the current dichotomy between equity and debt indicators that were hinted at in last week’s post there appears to be more risk of capital loss in many alternative funds than investors perceive.

Surge in Introducing New Alternative Funds

As with most “new” ideas, nothing is rarely new, but a reworked old idea in new clothes, often the famed emperor’s new clothes. Early British Trusts as well as US vehicles were primary concerned with the preservation of capital for multiple generations; an idea that appeals to me and many of my investment accounts. The adopted solution used in many cases were the selection of investments that often move in inverse directions avoiding chances of complete destruction from a single event, think of Lloyd's Shipping syndicates. As these investment vehicles grew an additional defensive mechanism was added, diversification. Thus, in the US many of the first funds were balanced funds that held diversified bond and stock holdings. Still today many bank trust accounts as well as other institutional investors compare their investment performances to the Lipper Balanced Fund Index found in the Wall Street Journal and currently produced by my old firm. However, the traditional Balanced fund has been replaced by a whole category of Mixed Asset funds with current net assets of $2.2 Trillion or roughly equal to the total US hedge funds and in the same region of US listed ETFs (Exchange Traded Funds). In Canada Balanced funds are the single most popular fund type.

From this base many new funds were launched with the same desire; that is to offer to investors a less risky way to achieve good upside performance with controlled downside risk of loss. Right now there are approximately 500 of these products on offer in the US. Recent trips to Canada and Europe revealed that alternative funds have become a hot sales item. Almost all of the newer versions of Balanced funds in addition to stocks and bonds of various types include derivatives, private equity, venture capital, use of leverage, and selling short. In the past, there have been a handful of experts that have produced very worthwhile results individually with these types of investments.

There are two types of risks in these funds, the management company created risks and the inherent investment risk in the asset class. Many of these vehicles are being produced and sold by investment groups that have hungry indirect and direct sales forces for new products after several years of lackluster performance from their historic book of business. They either try to develop portfolio management talent internally or hire past winners in smaller shops with significant incentive contracts. Considering many of these firms past history to me either approach adds to the risk in their vehicles.  As we not only invest for clients and ourselves in many mutual funds, we also invest in many of the world’s publicly traded management company stocks. Thus we measure results from different vantage points. This is similar to a comment in the recent The Economist on celebrating the 100 anniversary of Einstein’s 10 equations where they said “What you measure depends on your vantage point.” To us the long term profitability of the management company contributes to the attractiveness of some of its investments, particularly in markets that are crowded with good competitors.

The inherent investment risk in most Alternative Investments is based on the structures of interest rates and credit conditions. Granting a huge assumption that the specific portfolio is not at risk as to what looks like significant changes coming, other portfolios will be at risk and that will cause prices and flows to change, perhaps in an unpredictable fashion.

Fixed Income Indicators of Investment Risks

The market speaks often in numbers and price movements not providing full explanations. For example:

Last week Barron’s measure of “Best Grade” bond yields declined 3 basis points to 3.75%. indicating an increase in popularity for high quality. In the same week its measure of yields for intermediate credits rose 6 basis points to 5.12% measuring some uneasiness about intermediate credits. (One might look at these relationships and postulate that the stock market is not in danger of losing assets to bonds until short-term rates run up to 3.75%  to 5.12%. I have always believed that the Bond Market is a better analyst than the stock market, as it has to be, for it has a lower upside potential.)

Last week one of the credit agencies noted that since there has already been 99 defaults this year, we will soon be in a triple digit period which is likely to grow.  Considering in general the relatively low revenue growth of non-energy companies, the odds favor more defaults and are the reason for the increasing of the yield spread on “junk bonds.” Stock funds including ETFs had inflows of $2.9 Billion and Bond Funds had net outflows of $2.8 Billion in the week ending before Thanksgiving.

By nature I am uncomfortable with crowded markets because the participants often accelerate their price/volume actions to get out of the crowd as fast as they can. Thus, I found of interest that Bank of America/Merrill Lynch produced a list of the four most crowded markets in the eyes of hedge funds:

 1. Long US Dollar

 2. Short Commodity Stocks

 3. Short Emerging Market Stocks

 4.  Long US Tech Stocks

If I had long-term risk capital, my instinct would be to take the opposite views of these hedge funds for the first three and possibly the fourth bet.

The three Alternative investment objective classification averages on a year to date basis are minimally above or below the average of US Diversified Equity funds and well below the average Large Cap Growth fund and other funds that own the “FANG” Group = Facebook, Amazon, Netflix, and Google or a slightly larger group known as the “Nifty Nine,” including the first four plus Priceline, eBay, Starbucks, Microsoft, and Salesforce. Both groups are up 60%.

Perhaps, the most salient point of analysis is that because of the other somewhat dour coverage I did not see the need to go over to the Mall at Short Hills to report “good, but not great” Black Friday. I will be interested to see how the merchants handle their inventory liquidation.

Question of the week: How much risk do you perceive in your bond holdings?     

_________   

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Worry Short-Term, Focus Long-Term

Introduction

“The world is too much with us” is the title and first line of a famous sonnet by William Wordsworth.  One of the truisms of the media world since the first regular competitive publication is that bad news sells. If one scans the front pages of daily papers as far back as possible, one may see that bad news gets a bigger play than good news and normal news is relegated to the less important sections. Now that we live in a social media/electronic world look at all the bad news that we are bombarded with everyday. Also notice that the world, the country, most businesses and individuals have not come to an end.

While a few can make some money with short-term trading approaches, most who attempt to do it on a day in/day out basis contribute to the wealth of various agents until their capital or personality is exhausted. When Bernie Baruch was testifying before the US Congress about the trading that preceded “The Market Crash,” members of the committee were eagerly waiting to pounce on anyone who made money in the market. They were pleased when he announced to them that he was a speculator. Then they were downhearted when he explained the Latin derivation of the word meant to see far ahead. (As I have observed in the past, subsequent to the hearings he chatted with my grandfather on a familiar park bench and also counseled various US Presidents.)

Using the passage of time

Taking a leaf from Speculator Mr. Baruch, I worry about the current conditions, but try to focus on the long-term. One way I do this is with the development of the four Timespan Portfolios^* that I am developing for clients. The first or Operational Portfolio is very much currently-oriented, with the need to pay for the next two years of expenses to meet the crucial needs of the account. Any unexpected shortfall will starve some important need. Nevertheless, over a reasonably short period of time the operational capital will be all consumed. To meet the continuing needs of the account it must be replaced. That is the function of the Replenishment Portfolio which over the next five years must replace the Operational Portfolio. While there is nothing magic in five years it does represent a political period from leadership elections, the minimum expected presidency of corporate CEOs, some turnover of critical middle management and certain voting blocks. Some may prefer the four year US presidential cycle up to a Biblical 7 year period. 

^* Timespan L Portfolios^TM

In any case, based on past history one should expect a market decline during this period of about 25%. (If one does not see it in that period, be particularly weary because a bigger decline is likely.) During this timespan the markets are likely to be somewhat balanced between cyclical and secular trends with each playing a predominant role for part of the time. During this phase price-disciplined value buyers as well as those market players seeing expanding growth have a place in these portfolios.

Personal and institutional endowments

Even my friends who feel that they are already ancient are likely to need to use a part of the Endowment Portfolio which should have a focus between five and fifteen years. These portfolios ought to be largely invested in reasonably consistent growers of sales, operating earnings and dividends. This period is long enough to recover from periodic declines. Rarely there is an equity portfolio that has produced a negative result over fifteen years.

The Legacy Portfolio

The final Timespan Portfolio is the Legacy Portfolio which should be loaded with lots of emerging growth opportunities, recognizing that a number of these will fail as businesses but the survivors will more than make up for the failures. The focus of this portfolio is beyond the current horizon and will be largely dictated as to how technology acts on our world. Thus smart users of technology as well as their producers should be important investments in this prudent portfolio.

Worries

If I am primarily focused on the long-term in selecting investments for the Endowment and Legacy type investors, I cannot avoid occasional short-term losses caused by relative changes of marketplace popularity. What I worry about is too much enthusiasm in an up market. This is not a major concern today in the equity market. Excess enthusiasm however is very prevalent in the fixed income market. The owners of various fixed income instruments have convinced themselves that they know the future levels of interest rates and how they will evolve. This certainty is a worry.

A major decline occurs when there is a sudden shift in sentiment. One of the very reasons some fixed income investors have done very well is that the dealing community has shrunk. With fewer well-capitalized dealers, price trends become exaggerated beyond their appropriate value levels. This has helped on the upside and will hurt materially when the eventual decline hits fixed income.

My first worry is equity market capital will be drawn into the fixed income market to replace the missing levels of liquidity, the withdrawal of capital from the equity market could trigger a stock market sell-off of significant dimensions.

My second worry is in stock markets that are experiencing higher than currently customary volatility. We are seeing the 2015 leadership shift to more growth companies, particularly of smaller market capitalization. Biotech funds are producing year to date performance twice to three times Growth Stock funds and this is a global trend. Part of this excitement is due to very highly valued acquisitions.  A number of these stocks are gyrating well above many consumer and industrial stocks that are suffering from mixed to mediocre sales and limited opportunities for margin improvement. I can not guess how high this move will be, but I remember from years ago that I used to track funds that were up more than 100%.  As a matter of fact I had to explain to a board of directors that the poorest performing Tech fund was doing a good job being only up 100% with others producing almost double those returns.

My real focus is to avoid big declines that are likely to come from very extended stock market prices. I am not sure about that likelihood for fixed income prices.

Question of the week:


What are you worried about long-term?
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