Investors’ Interlude - Weekly Blog # 937

 

 

 

Mike Lipper’s Monday Morning Musings

 

Investors’ Interlude

 

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

 

 

 

Take Some Gains Before Taxes Do

The common denominator for most big investment gains are changes. Usually changes in investor perceptions and economic structural changes. The Standard & Poor’s 500 (S&P 500) and NASDAQ Composite are at record highs, due largely to enthusiasm for announcements related to the suspension of fighting in the Middle East. (This is not true for the Dow Jones Industrial Average (DJIA) and the average stock.  Unfortunately, since WWII the US has had a history of winning wars but losing the peace.)

 

We do not know the total cost of the war and other spending, including election-oriented payments. I suspect the President’s desire for a lower valued dollar will be achieved. There is also a strong push from urban legislators for “fair taxes”, also known as “tax the rich”. Thus, I believe capital gains rates and estate tax rates will rise.

 

Due to these expected changes long-term investors should review their portfolios to see how much of their wealth should be realized before their estates are taxed. If this generates significant amounts of cash, I suggest maintaining the cash or short-term treasury holdings for reinvestment.

 

I believe there will be positive changes in the foreseeable future. These changes may be driven by technology, demographics, immigration, and global factors. These changes are likely to be net larger than politically motivated changes and you want to be in position to take advantage of them.

 

Investment Impacts of Past Changes

The Founding Fathers were afraid of the powers of government, so they placed our Capitol in the humid swamp of Washington DC, thinking our legislators would desert the “swamp” during the humid months. That worked reasonably well until the development of air conditioning. The end of the government’s year is now September 30th, after the summer political conventions, which reduces the time for debating many of the critical issues of the day. DC is now a year-round city for government workers and legislators. Many work or live in large buildings constructed and possibly owned by real estate families who are probably wealthier than the US Senate members. Thus, the advent of air conditioning changed how our government works.

 

Another unexpected change was the railroad growth of the late nineteenth century. The highly regulated railroads only made profits on freight travel and lost so much money on human passengers that the federal government became the principal owner of passenger travel. The freight lines are governed by both the Department of the Interior and Anti-Trust laws. This has led to other countries having better and cheaper train service than we do, paid for by charges on the goods we consume. It is interesting to note that the Dow Jones Transportation Index, which covers the rails, was the best performing market index this past week. The rails are still important.

 

Future Changes

We live in an environment of an increasing rate of change. I leave to others to identify the changes which most investors would not be surprised by.

 

Geographic Changes

1. Western Hemisphere countries have become more partners than adversaries in terms of trade, health practice, external and internal defense, probably led by Canada.
2. Russia, after Putin, will experience major political and economic changes.
3. Asian countries that border both Russia and China will come into their own in terms of trade and be more open to development.
4. African countries will welcome joint development from Western countries.
5. Indonesia and India will become less autocratic, with foreign companies able to generate substantial sales and earnings.
6. Each country will make their own rules.

 

Retirement Issues

1. Over time, US Social Security will be allowed to exclude US government paper and possibly approach being a foreign wealth fund.
2. It is reasonable to expect that those born recently will live to at least one hundred, so we will need to provide for longer periods of investment and spending.
3. For the same reason, private retirement vehicles will need to change.

 

Market Regulation

1. Using the last trade may no longer be appropriate if it is too small and unrepresentative of the size of the seller.
2. As more stocks and possibly bonds trade in size in after-hours, having a closing price on the exchange market may be unrealistic.
3. From a technology perspective, there should be a body that can approve of their use for retirement accounts.
4. Should issuers of a certain size be required to have assets or insurance on the life of the CEO that can be used in retirement accounts.

 

As usual, I would love our subscribers to share their views with me. 

                                        

 

 

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

Mike Lipper's Blog: Not Yet Ready for a long-term Solution - Weekly Blog # 936

Mike Lipper's Blog: We Have a Management Problem - Weekly Blog # 935

Mike Lipper's Blog: Is History Rhyming Again? - Weekly Blog # 934

 

 

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Stud Poker, The New Swamp Game - Weekly Blog # 661

 

Mike Lipper’s Monday Morning Musings

Stud Poker, The New Swamp Game

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

The never-ending battle between Principles and Principals for the swing votes is entering a new phase that will impact investors. Since ancient Greece’s limited democracy, historians have described the battle between Principles and Principals for political control in capturing a relatively small number of swing votes. Most historians put us at a disadvantage in analyzing the conflict, as we do not have a useful understanding of what really happened. Most historians rely almost exclusively on after-the-fact comments from those supporting various uplifting Principles, because there are easily available texts joining the believers in the nice sounding principles. The other side, regardless of winning or losing most of the time, leave evidence of the tactical moves that led to their success. Very few people produce a contemporary tale of the emotions that drove them to their decisions. At best we have an incomplete outline of what they did. Human Principals are by nature executors and at best leave a history of their successful deeds.

“Where Are We Now?” 

Regardless of the final result of the two Georgia Senate races, we will be in an era of divided government. Beneath the surface we are likely to see deep splits within both parties, with different factions positioning for 2022 and 2024 elections. In addition, various members need to build or rebuild the “mother’s milk” of politics, contributions. Many need to be seen as advocates for various local interests, which may conflict with the views of the national parties. It is worth remembering that the last national elections were fought primarily over unattractive personalities rather than uplifting principles. (Remember, US voters often express their negative views by voting for the opposition.)

Elected vs. Unelected

The number of elected representatives in Washington are under 600. The number of decision makers in various government departments and agencies are clearly many multiples of the elected people. Additionally, there is the political crowd, including official lobbyists and so-called “think tanks” following questionable principals. For the most part they are permanent residents in what is known as “the swamp”. Not only will they outlast most politicians, they are experts at manipulating the dictates of elected government.

Despite the egocentric nature of those in the capital, outside forces occasionally impede the political will of the elected leaders. The pandemic is just one such influence. Also both technology and economics increasingly have an impact. But let us not forget what is probably the most powerful force impacting almost everything, demographics. 

“The Game”

To understand the game, look at the page count coming out of the so-called “Stimulus Package”. The Democratic Leadership put out a single page of what they believed were their accomplishments. The senate driven bill was in excess over 5500 pages, a clear example of a negotiation by Principals. 

The incoming administration looks to this legislation as an example of bipartisan cooperation. The President-elect’s history in the Senate was not based on initiating legislation but working on compromises. The main bargaining chip in the likely compromise with the Principals is often identified with the letter “C”, or a passing grade. Three of the C compromises, often delivered outside of specific legislation, are Contracts, Clauses, and Circuits and Federal departmental judgeships. Large government contracts with sweetheart provision clauses are often favorable in terms of taxes, tariffs, and regulations. They also regularly secure contributions and votes. Circuit or department judgeships are worthwhile endeavors to instill a “friend” in the court.

Stud Poker Model

Watching legislation go through Congress and the White House is similar to the progress of a single game of stud poker. Stud poker, a seven-card game among a handful of people, was popular among political types for many years. It starts with each participant receiving two cards face down and one face up, followed by a round of betting with some players dropping out. It is followed by three rounds of getting a face up card and additional rounds of betting and/or folding with each card. The seventh card is dealt face down, again followed by a round of betting. One can win by being the sole survivor if all others drop out due to seeing both the exposed open cards and their own cards. You can also win by evaluating the face down cards and interpreting the betting and actions of others. The skill in the game is first assessing one’s own likelihood of getting a good hand, by knowing your own cards compared to the possible hands of others and the impact of their betting. There are two ways to win, have better cards than others or convince them that you have better cards where they fail to match your betting. You buy the pot of all that was waged without turning over your face-down cards. Poker is simple compared to Washington politics, with known and unknown cards.

In seeking a legislative compromise it is important to identify the strength of conviction that a useful benefit can be secured in reasonable time and determine what has been promised to others. Often, the more experienced legislators or their top aides can create an advantage that more junior Congressional members are unable to. 

Let the games begin!!  

What to Do?

As with more questions, it depends on your goals, measurements, and tolerance for disappointment. The answers for most of these questions is very dependent upon the time-period and measurement applied. The shorter the time-period, the less influence of timing decisions. Based on past experience, there have been 25% declines in one year and 50% declines in a couple of years or more. It is the measurement method which causes the most trouble in my opinion. In choosing between a very limited number of alternatives it is easy to measure absolutely, although with a large number relative performance is often more realistic. Most measure by comparing against a mathematical average, which is heavily influenced by the extreme performers. The more mathematically oriented may use the middle result or median in an array, which is preferable to me. With a large universe of competent players I prefer to subdivide performance into quintiles, avoiding the knife edge of quartiles.

I tend to view the performance within any quintile and particularly the third quintile as almost random, with a small number of extreme results being difficult to repeat. When managing in a competitive league that encourages shifting managers frequently, data from the current best performers is often used, not by me. For accounts having stringent absolute payments requirements, I prefer to measure against absolute and relative capital preservation. 

Now?

I prefer to work with long-term investment horizon accounts, where demographics, discipline, savings habits, intellectual-honesty and productivity of the labor force tend to structure my working framework. I don’t make any strategic changes, as some tactical changes will be required due to fundamental changes within the specific investments themselves.

As distinct from the long-term accounts, those that have effectively fixed or semi-fixed payment requirements need to balance the risk of reduced actual or anticipated payments with the generation of future sources of income production. Depending on the specifics of the account and our perspective, the mix between the two motivations is within a 30-70% mix. (This is not an essential prescription to the standard balanced fund’s stock/bond ratio, because both bonds and stocks may have capital risk and appreciation opportunities.)

As we enter the new year, the first of a radically different administration and a shifting power base, investing for the short-term in a competitive environment is going to be difficult. At times investments are priced cheaply in terms of their fundamentals, whereas at other times markets price securities near their probable top. In the last week of 2020 I don’t know whether we are closer to one extreme than the other.

As often the case when I am faced with a decision, I attempt to follow a sales prescription from Ben Franklin’s commercial activities and make a list of positives and negatives. Some salespeople convert these lists into a form of a balanced sheet, which surprisingly almost always has more positives than negatives. Before producing my lists I should identify my anti-momentum bias. Much like at the racetrack, I don’t have to bet on every race or market condition and the bulk of the money I am responsible for is long-term. (Think beyond this decade.)

The US stock market has fluctuated in a relatively narrow trading range this autumn/early winter period. Only after a material market move will we be able to determine if this was the distribution of risk from smart investors to less smart, or an opportunity for smart investors who perceive the near-term future as being materially better than what we have seen in the last four years. Thus, one can say that the current market brings together sceptics and believers. 

As the volume of transactions compared to the number of shares outstanding is low, one can see that there is not an overwhelming consensus view by market participants. Most of the money is invested for the long-term, at least beyond the incoming administration’s period in office. In the last two weeks of 2020, sceptics are selling to protect their capital gains from possible changes in tax rates on income and estates. s Buyers perceive an expanding domestic economy and a less turbulent world.

Positives (Random order)

1. The crowd at The Mall at Short Hills appeared to be larger on the first shopping day after Christmas than the days before the holiday. We guess the crowd had to line up and be temperature tested before entering big brand clothing and jewelry shops. The longest lines were at the Apple (*) store. Restaurants were busy and had lines, indicating that shoppers were committed to spending hours shopping.
2. I believe we are in a somewhat new investment era because of COVID-19 and global technology’s impact on consumption, suggesting our favorite numbers are out of date or out of scale. Key relationships between risk and reward probably remain reasonably constant, but not their number identifiers like P/E, yields, stock/bond ratios, turnover rates etc.
3. Shortages permit big price increases e.g., intra-Asia shipping container prices being up 450%. On a broader base JOC-ECRI Industrial Price Index is up 23.87% year over year. 
4. Long overdue stock leadership rotation in favor of small and midcap stocks will bring more capital into a needed sector. Tech focused stocks have returned temporarily to leadership.

(*) Personal position

Negatives

1. 62% of this week’s WSJ roster of prices declined.
2. A consumer confidence survey, expecting a +97% reading, came in at 88.6%.
3. Some strategists see meaningful risk in the Middle East and China. In the former case, strained budgets will force risky expansions. In China’s case, a further crackdown on debt creation is expected.
4. The Biden administration relying on people for material economic expansion based on their Obama Presidency experience.

Subscribers, please remember the two iron clad rules of investing:

1. The only guaranteed product of the market is to create humility.
2. Surprises happen because most don’t expect them.  

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

https://mikelipper.blogspot.com/2020/12/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2020/12/searching-for-surprises-weekly-blog-659.html

https://mikelipper.blogspot.com/2020/12/an-investment-dilemma-with-possible.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.

Your Investments Right Now: Hold or Fold?

One of the techniques a former Director of Research of a major firm used in interviewing a candidate for hiring or promotion was to play poker with him/her. How the player handled him/herself, he believed, told him a lot about the person’s analytical abilities, risk-reward sensitivities, and to some extent, their integrity. In the modern era, poker has become both a casino and an electronic game. Regardless of how the game has evolved, there comes a point when each player has to decide to hold his or her position in the game by at least matching the last bet, or declining to do so by folding.

The investing game

While investing should be, and is for most people, a serious activity, some of the thinking that permits players to walk away from the table with their (hopefully augmented) chips, is useful. At every minute in the trading day the investor has the choice to stay in the game and accept today’s risks or to fold, perhaps to play on another day.

Okay coach, what do I do now?

As long as you don’t tell anyone, I will admit I do not know which way the market will go. I join both Peter Lynch and the late Sir John Templeton, who professed not to know (or to particularly care) about short-term movements in the market.

The rest of this post is in response to some members of this blog community who feel under pressure to do something.

The stock markets have been declining throughout the second quarter, which is about to end. The quarterly reports will attempt to focus on the first half results, which will be for the most part positive. Nevertheless, a lot of pessimistic comments are being generated by the single digit losses in the second quarter, and constant focus in the press on bad news. Uncertainty is a word that will be used by various political and economic commentators. Some may believe that there will not be sufficient clarity until after next year’s US elections for the Senate and President. (I placed the Senate first because in my mind it is more important in the long run as to the structure of the US, and to a lesser degree, international political and economic structure.) Some may feel that too much can and will go wrong, and want to exit or fold on some of their investments now. A good coach wants to win the current particular contest, but a great one wants his players to achieve long term success.

Don’t do “It” now

By definition, the optimal time to sell is when something is priced at an unsustainable level. With the exception of a limited number of new issues and some commodity plays, we are a long way from prior peaks or future valuations based on “normal growth and conditions.” Some with large unrealized profits may be concerned about the end of current capital gains tax rates. (If that were to happen, it would be in 2013.) For the ultra high net worth among us that are building inheritance and trusts for future beneficiaries, there is the after-tax risk of timing the re-entry into the market. Most of my clients are more concerned about the long-term future of their capital than the current size of their piles of poker chips.

I need to sell; what do I do?

The following is a series of thought patterns to guide the current seller:

1. If you believe that we have rolled over into a bear market, examine the history of your fund or securities in the last couple of bad markets. We have recently done that on a list of funds of interest to a particular client. While we did find some funds that were in the lowest quintile in the last two bear markets (2000-2003 and 2007-2009), the reason they were on the list of funds of interest is that they had spectacular bull market performance. Thus, if you believe we are much closer to a bear market that might last until after the elections, one might choose to exit these funds. Be careful, getting the timing right near a bottom is very difficult. Most people come in to a subsequent rise late, after the easy money has been made in the early part of a recovery.
   
   
2. If you believe that the current market recovery is getting old, you may want to look at your portfolios for your best performers. Have they done so much better than other investments to make their stock prices vulnerable? For some time small market capitalization stocks have done better than large-cap stocks. On average, Small-cap Growth funds are up +6.02% year-to-date through last Thursday, June 23rd, compared with the average Large-cap Growth fund being up +1.88%.
   
   
3. Popular investments experience a crowd effect, with many of the well known pundits in or out of the media calling attention to particularly good results and/or intriguing personalities. People join the crowd late and usually take the pundits’ word that the touted security is a good investment. As expectations are not met quickly, the crowd dissipates, perhaps causing a redemption run. So if you must sell, look at the former media darlings.
   
   
4. If you invest in sector oriented funds, keep in mind they can move much faster in both directions; and if you want to reduce your downsides you could cut back on these leaders, e.g., Gold and Silver oriented securities. At this point, one of the underperforming sectors is the Science & Technology group. Currently, there is much happening that may change the nature of competition among these companies, which creates both outsized risk and rewards; thus extreme selectivity is warranted. The worst performing sector in the US (and elsewhere) is the financial sector, with the average Financial Service funds down -5.27% year-to-date. As a manager and investor in a private financial services fund, I have mixed emotions. I am unhappy with the performance of the sector, but I can understand it, as can my long-term clients. On the other hand, any additional massive selling of the sector is likely to create bargain prices that we have not seen in many years.
   
   
5. I believe the biggest risk to many portfolios is their high quality and short-term fixed income holdings. Except for TIPS (Treasury Inflation Protected Securities), the risk to your purchasing power is high and going higher in the other securities. At this point in the cycle I would suggest that there is more credit risk than current prices can accommodate. If you are cutting back on your equity exposures, I suggest you cut back on their “kissing cousins,” high yield securities and funds. The higher the current yield, the bigger the risk according to the market.

Twin Conclusions

Long-term oriented investors should hold on; this particular period of uncertainty will be over relatively soon. For those who feel they must exit some of their portfolio, do it wisely. Be willing to cut back on some of your outsized winnings.

As a paranoid spectator, I wonder whether there is any long-term significance in the fact that the plane crash earlier this week in Russia had five nuclear scientists from Iran who were purported to be working on the peaceful use of an Iranian reactor.

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