Is This the Last Hurrah? - Weekly Blog # 945

 

 

 

Mike Lipper’s Monday Morning Musings

 

Is This the Last Hurrah?

 

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

 

          

 

 Preface

Hurrah is both a shout of victory and a political world about aging politicians, warning that the following election won’t be a happy one. (BTW it is pronounced Oorah in the Marines and Hoorah by the Army.)

 

I don’t know whether the reception for the largest IPO of all time is a sign we will not see larger market enthusiasm in the future. I am talking about both the size of the SpaceX offering and the further gains generated after underwriting.  What I do know that it was a record fundraise at a time when many non “AI” stocks are dealing with mediocre sales. Consumer sentiment is at its lowest on record going back to the early 1950s

 

More importantly, I am trying to find investments for the next “bull” market. My assumption is that we will experience a substantial rise after a major correction to the present market level.

 

The Process

The first thing I don’t do is look for clues to a different future by crunching GAAP numbers found in today’s annual reports or other regulatory accounting statements. To the extent present sales data may be useful, they need to be adjusted to match reality. For example, today it looks like semiconductor companies are doing very well in Taiwan and South Korea. Truth is, only some of their product sales are produced in their home country, with increasingly more in other countries. More importantly, I am guessing their ultimate sales are to US customers. Thus, investors are concerned that many of these so-labeled international companies are extremely sensitive to what is happening in the US.

 

Forward Looking Analysis (Guessing)

The example that I discuss should not be treated as a buy recommendation and should only be rendered knowing the economic condition, resources, and personality of the buyer. The case I will discuss shortly is a long-standing large position with a large unrealized potential tax liability, although the analytical thinking may also be appropriate for the reader.

 

The stock is Berkshire Hathaway. The news item is the $8.5 billion purchase of Taylor-Morrison Homes for cash, including the assumption of some debt. The initial size is about 1/3rd of Berkshire’s annual net free cash flow, excluding their large cash reserves.

 

The decision made by the new CEO of Berkshire was completed in matter of weeks and was applauded by Warren Buffet. The announced plan is to create a housing group combining Taylor-Morrison with already owned Clayton Homes, which manufactures homes at a lower price point. Taylor-Morrison builds communities of new middle-class houses as well as rental housing. There is a national need for more housing.

 

I believe this purchase is very similar to Berkshire buying See’s Candy, which was initially misunderstood by some as Berkshire going into the Candy business. They were instead going into the franchising business, which has been an excellent business for McDonalds. In this case they would be going into the home mortgage business in a major way, with a controlled sample.  Furthermore, this is a sign that Greg Able the new CEO of Berkshire, has different talents and proclivities than Mr. Buffet without the guidance of the late Charlie Munger.

 

This is an example of how to investigate the future. 

 

Let us know what you think about our views?

                                         

 

 

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Premature: Buying Program to Begin Soon? - Weekly Blog # 931

  

 

Mike Lipper’s Monday Morning Musings

 

Premature: Buying Program to Begin Soon?

 

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

 

 

 

Basic Investment Principle

Investment opportunities are cyclical in both timing and magnitude. Larger gains are achieved after periods of extended declines. Since one does not know the extent of a decline or magnitude, it is wise to use a buying program. For instance, invest no more than 10% of buying reserves at any time. (This assumes you establish a buying reserve in rising markets. Charlie Munger has taught us to buy good companies at fair prices rather than always look for “cheap” prices.

 

Recently, my sister-in-law sent me a copy of a letter from my grandfather to my late brother sometime after he left the Marine Corps to begin his life in the investment business in the mid-1950s. My grandfather, who built his own brokerage firm for more than thirty years, cautioned my brother to always expect periodic recessions and less frequent depressions. He also advised him to not invest against the US, as the country was rich in natural resources. (This is still good advice, but there are times when our government makes our currency risky for a period.)

 

Where are We?

Most investors in defining where we are, do so by looking at where we have come from. The pundits wax poetic about recent data extrapolations, expecting the past to be repeated. My analytical training at the New York racetracks and as a US Marines Corp Officer was to always examine the current situation and expect some change.

 

Today, many pundits and politicians see an improving picture. As a student of financial history, I am conscious that it has been some time since the last recession. Furthermore, it has been 97 years since the Wall Street crash and the 12-year depression. Few people recognize any similarity between that time and our current condition.

 

Trading Alerts-Correction, Recession, or Depression?

The following are a number of alerts from last week suggesting we are entering a period of more declines than increases:

1. Morgan Stanley is planning to cut 3% of its customer-facing workers.
2. 73% of stocks traded down on the NYSE and 67% on the NASDAQ. A pattern which has been going on for several weeks.
3. The ECRI industrial price index rose to 126%, a 4.73% gain year over year. Clearly, the war in the mid-east is inflationary. 85% of prices tracked by the Wall Street Journal each weekend declined, echoing the ECRI results
4. Individual investors and those serving retail investors are not confident in their outlook for the next 6 months. 33.1% are bullish and 35.5% bearish.
5. The S&P 500 index is the best indicator of the market for both institutional investors and wealthy investors. Along with most other indices, the S&P 500 index fell on Friday. If this was the beginning of a recession and the index were to decline to where its rise began, it would drop 28%. If this was the beginning of a relatively mild depression, the drop could be 49%.

 

Advice to Buy Program Buyers

I have found it extremely difficult to buy at the exact bottom, as most declines don’t appear convincing enough. The advantage of using a buy program strategy instead of a one-shot purchase is that you will likely have a collection of winners and losers before the overall market has reached back to its original starting point, assuming you buy 10% each month or quarter. However, that is not the point of the exercise. You should want to hold your position until it has reached the condition of a great company at too high a price, where some trimming makes sense.

 

Please share your thoughts with us.   

 

 

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Mike Lipper's Blog: Expectations Changing? - Weekly Blog # 930

Mike Lipper's Blog: Diversification - Weekly Blog # 929

Mike Lipper's Blog: To Win Long-Term, Learn From Great Presidents - Weekly Blog # 928

 

 

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Not Yet! - Weekly blog # 800

 

Mike Lipper’s Monday Morning Musings

Not Yet!

 

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

 

 

 

The Thinking Behind Blog 800

When I realized the 800^th blog was coming up I tried to think of something special to discuss, like a critical turning point at the beginning of a new long-term market cycle. I see a turning point in the future which will begin a new corrective cycle. It will address multiple imbalances facing the US stock market, a reflection of increasingly problematic domestic and global problems.

 

However, it now appears we are likely going more toward a shallow dip, which could be labeled either a “soft landing” or a ripple in a stagflation period. Regardless, the underlying tensions continue to build and they will eventually lead to a deep corrective stage. With the 100^th blog less than 4 full years away, I have high confidence we will see a major correction.

 

Regardless of the timing and depth of the correction, we remain largely invested in equities and stock funds. These funds will need guiding principles to survive the correction and prosper from the following “bull” market.

 

Sources of My Guidelines for Long-Term Successful Investing

• Fidelity has published their views on 5 mega trends.
• Marathon in London has written about the benefits of low turnover and stable managements.
• Howard Marks expressed his views on escaping extreme investing.
• Finally, my own observations on the investment decisions of funds, commuters, and actuarial lessons on betting.

 

Productivity/Profits- Fidelity

Fidelity probably invests in almost every investment any place in the world. They serve different types of clients in many capacities and countries. Of the 5 Mega Emerging Trends, the most easily measured is the slowdown in the growth of productivity, more specifically in the productivity of labor. Labor is easily measured in terms of the number of hours committed to work, likely for compensation. (What is not evaluated is the quality of the work.) The number of hours worked in the US is in the upper portion of the lower half as shown below:

   More than US      US    Less than US

UAE          2709  1892   UK        1866

India        2480         Germany   1783

China        2392         Australia 1669

Mexico       2220         Canada    1664

South Africa 2154         France    1565 

Thailand     2108

Poland       2085

Indonesia    2043  

Philippines  2039  

Russia       1965

 

Implications

1. In a world that has higher interest rates and is short of opportunities, there are more places competitive with the US.
2. When US proclaims politically motivated holidays, such as Labor Day.

 

In an article by Howard Marx, he warns about extreme stock prices. When extreme enthusiasm pushes prices to record highs or lows, investors sell stocks priced for perfection, or buy/retain stocks which can never generate good news. Most of the time securities trend in one direction or the other. A dangerous condition is when all opinions on a security are totally one-sided. Very few investors understand that it is rare for there to be no salvage value for knowledgeable investors with patience and legal backing.

 

An example of too many one-sided beliefs was the 50 institutionally favored stocks in the early 1970s (Nifty Fifty). It was believed that these stocks could be bought and never sold, after the recommendations of the leading institutional brokerage houses didn’t work out. In 1972 the list contained Eastman Kodak, Polaroid, Sears, and Kresge. In the years that followed, all four disappeared through bankruptcy. To demonstrate how much reputational power these stocks had. One senior investment officer was an early promoter of Polaroid and managed to ride that performance into being hired as the senior investment officer at a New York based mutual fund house. He didn’t last long in a company that was studied daily, including its longer-term performance.

 

Marathon in London has a successful record with its European fund and others. They are a low portfolio turnover shop who pay a lot of attention to industrial and corporate capital cycles and meet with long-term senior management extensively. They are very proud of the 26% of their portfolio that has been held for more than 10 years in the European fund. Those positions represented 45% of that portfolio at the end of the period. When I visited them, I was amazed at their detailed knowledge of their companies, managements, and critical competitive information.

 

There are many investment lessons I have learned from just observing and listening to people. For example, I suspected the market was getting frothy in the late 1960s when a person I commuted with on a 6 AM train mentioned he had gotten a personal computer and was going to stay home and day trade a handful of stocks. He was a mid-level executive at a famous financial institution and appeared to have average intelligence. I was working for a firm that had a very active trading desk that regularly dealt with some of the sharpest trading shops. Very occasionally I heard one-side of a phone conversation between the traders. I felt I needed a translation regarding their words and tactics. I am sure my former train buddy knew no more than I did about institutional trading. Hopefully he learned quickly or found a new job. I never saw him on the train again.

 

I owe UPS a gift for the two investment lessons I learned from them this week. There was a public announcement that the company was offering early retirement to 167 senior pilots. Each of their planes carries about 30,000 packages and is designed to fly every day. Consequently, in terms of delivery capacity, it meant UPS would deliver 1.8 billion fewer packages or these packages would be flown by less expensive junior pilots. It suggested to me that UPS was expecting less business after their expensive settlement with their truck drivers. Within the week our friendly regular UPS driver delivered some low value drug store items, which may have come from a warehouse or a local store under half mile away. In either case, it was not a bullish indicator for me.

 

During the very same period institutions were locking into long-term investing in the nifty-fifty stocks, there was a more valuable lesson a few miles from Wall Street. On a Saturday in June of 1973 the Belmont Stakes was run. It was not much of a contest. Secretariat won by 31 lengths, setting a track record. While that was interesting, the real lesson of the day was that I didn’t bet on what was clearly the best horse in the race. More importantly, I did not bet on any horse in the race. When Secretariat won, the horse paid $2.20 for each $2.00 bet. What I learned was that even with the best horse in the world things can happen, or if you will “racing luck” might happen. (Sounds as if I was conscious of Howard Marx’s avoiding absolute certainty.) I was practicing good actuarial science, which excludes events so rare that they are unlikely to reappear. What I learned was that to not bet is a bet. Wagers should only be made when the odds of winning are high enough to cover losses in the past or in the future.

 

Conclusion

Investing should not be considered a single chance to make or lose money. The more you are aware of the world around you, the better your chances of finding some winning investments and keeping your losses small.

 

 

 

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My Outlook: Nervous Balances - Weekly Blog # 767

 

Mike Lipper’s Monday Morning Musings

My Outlook: Nervous Balances

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

 

 

 

Nervous Dilemma Positioning

My traditional allocation of stocks and bonds being close to a 70/30 split is somewhat misleading. A significant minority is in actively managed stock mutual funds with a financial services or international focus, often Asian. Financial services need a better label, so as to include two stocks of companies that are building their own portfolios that behave similar to variable annuities, Berkshire Hathaway and Apple. (The reason to call them annuities is that they are both primarily managed to produce long-term earnings, rather than current earnings.)

 

Financial services holdings as a group are also expected to fully participate in the growth of the US and International economies. In general, their strength is not in making loans, but in making money with equity. Consequently, one might characterize my equity investments as a combination of growth and value in more classical terms. This is appropriate as most companies have spurts of growth and value.

 

Time Horizons

For both my professional and personal/family accounts I start by designing portfolios built on an understanding (guess) of when and at what frequency the proceeds of the account will be delivered.

 

My particular situation is that I have a younger and healthy wife, with the fourth generation of the family begun. We are also committed to supporting the operational needs of a limited number of non-profits that Ruth and I have been involved with, both as volunteers and donors.

 

Short or Deep Recession?

I tend to look at various down periods through the late reporting of real net income (inflation/foreign exchange adjusted). Where possible, I prefer to use net operating income. Since 1970 the US has suffered 8 major declines of real reported income (-15% to -41%), with a median decline of about -28.5%.

 

The popular view today is that if we have a declared recession, it will be short and small. As someone who learned about odds at the New York racetracks I am nervous with popular views. Their payoffs are too small compared to the pain endured in the prior decline.

 

One theory of economic/market history is that declines are caused by imbalances, which are addressed during the recovery. If that pattern is followed in the next recovery, we may not yet have gone down enough. We need more time before the correction begins.   

 

The current path of major central banks is to follow the Federal Reserve Bank in attacking the supposed major cause of inflation with the only thing they can, short-term interest rates. The best definition of inflation is too many dollars chasing too few goods/services. The last two administrations contributed to these excess dollars, which were officially used to cushion the public’s loss of pre-COVID income with grants. (This was similar to the ancient Romans using bread and circuses to bribe people.) They are still at it!! This will make the Fed’s job more difficult and expensive.

 

Fewer people working should also drop the level of demand. However, despite all the increased regulation and required business spending, there are approximately 1.7 employees wanted for each current worker. This has created a situation where job switchers earn more than those who stay put. (If one really wanted to eliminate excess demand you could simply reduce restrictions on business.)

 

Thus, a shallow recession could be shorter if the federal government wasn’t playing both sides against the middle. This may happen later this year with their hope of a meaningful recovery by Election Day 2024.

 

Assuming this case, financial markets could start up as soon as economic indicators hit a bottom, with smaller declines. Which could happen this year. If this were to happen, our 70% equity stock fund portfolio would produce a nice but not great return. One area to consider for investment are funds that have lost money over the last 10 years through January 12. In general, these funds were victims of a strong US dollar. Included are funds invested in commodities, emerging markets based in local currencies, Latin Americas, and precious metals.

 

Second through Fourth Generations

While a recovery based only on lowering inflation and interest rates will generate returns for my wife and me, it would have little impact on succeeding generations, including various long-lasting charities.

 

The larger and longer-term problems that will reduce returns for succeeding generations will not be addressed by the level of interest rates. Most of these problems are related to people rather than numbers. These problems could be expressed as “Better for customers, workers, and owners”.

 

Below is a brief list of imbalances that should be addressed:

1.  Quality of leadership in each sector and operating unit of society, including levels of governments, segments of health and medical, education, and non-profits.

2.   Middle-class income as a percent of national income returning to levels of the past.

3.   Measured and productive population growth.

4.   Appropriate education for current and future needs.

5.   Governments of the people, by the people, and for the people.

 

Perhaps for the benefit of succeeding generations the appropriate investment strategy should include less exposure to risk until there is a deep enough decline to correct for imbalances.

 

Please tell me what you think?

 

 

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Mike Lipper's Blog: Bear Market, Recessions, Reinvestment - Weekly Blog # 765

 

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Switching Prime Focus - Weekly Blog # 739

                                    

Mike Lipper’s Monday Morning Musings

Switching Prime Focus

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

Functions of Analysts & Portfolio Managers

Many analysts who publish their work focus on just reported results, and to a minor extent estimates of the next to be reported results.

As a contrarian thinker, I am used to being lonely in examining longer-term results. Consequently, I accept that my views may well be very different than what occurs.

Portfolio managers should be focused on expected prices at termination of time periods critical to the account. That is the easer part of the job. The more difficult task is the construction of a portfolio to accomplish the investor’s goals within given time periods.

Both analysts and portfolio managers will only be right some of the time. The critical task is to limit the overall damage to the portfolio and achieve the best delivery for the investor.

Why Switching Now?

In almost all sports, as in life, the best results come from the appropriate combination of anticipatory aggressive and conservative moves.

Coming off a successful effort to call last’s week equity performance, where the Dow Jones Industrial Average (DJIA) generated an 800-point gain on Friday. News reports and commentaries have been more mixed than when I started to mention my more bearish comments over a year ago. With the NASDAQ in a bear market and both the DJIA and the S&P 500 in a correction, I should question my own views. (The S&P 500 was temporarily in bear market territory)

Bearish Comments

Former Democratic US Treasurer Larry Summers said, “We need unemployment above 5% to contain inflation for five years, 7.5% for two years, or 10% for one year.”

Corporations and individuals choose to move for a number of economic reasons, including the new location being better for their relocated and new employees. Citadel is moving its headquarters from Chicago to Miami. Both Chevron and Goldman Sachs are moving major portions of their office staff from crime infested, high tax states, to Texas. 

Copper prices have reached a 15-month low. A significant development due to its use in many manufactured products and economists calling it an economic predictor.

The prices paid for the “free lunch” SNAP program has risen 23% in a year. I don’t know how much of this is due to the war in Ukraine, but it does not seem this tragedy is going to get less expensive or end quickly.

Political Lessons

Almost all economic cycles are caused by humans. Among the easiest to spot and perhaps correct are those made by politicians in power from both major political parties.

Perhaps the single biggest problem created results from elected politicians turning over issues to non-elected administrators, which they do because they don’t have sufficient votes to pass them. 

For example, this weekend the decision on abortion was punted. Elected politicians in Washington, recognizing this topic was likely to split the population, decided to let the states decide. On Friday it went through to the Supreme Court, because in eyes of some, the local laws were in conflict with the US Constitution. We need to remember that the Supreme Court makes judgements based on law and legal precedent, not moral judgement. 

The mistake politicians in Congress made for a period of at least twenty years was asking candidates for their opinion rather than crafting a national law addressing the problem.

This is their common mistake, they turned to unelected and largely untrained administrators to solve a social problem. We see this approach being used for issues before the SEC, FTC, Treasury, State Department, Agriculture, Labor, Interior etc. (In my opinion, it is just a matter of time before various administrative decisions are struck down due to exceeding their legal mandate to act without passed legislation.)

One reason politicians act is polling, although polling has proven to be quite inaccurate in close elections. Polls are also conducted by low-cost brief phone calls to those willing to venture opinions to structured questions. 

In the days when I was interested in polling, I found how I asked the question influenced the answer. This is not an unusual view. It is no wonder a growing percentage of people called do not wish to answer the questions. These “no answers” are not tabulated or properly investigated.

Some Incomplete Conclusions

While I did not recognize it at the time, I took a graduate business school course entitled “Security Analysis” as an undergraduate at Columbia. The Professor was David Dodd, with the adjunct professor Benjamin Graham writing the first academically popular book on the subject. 

This is the course and book which provided the foundation for what has been called “value investing”. There were three problems in the way it was taught. 

1. It was based on the investment experience in the 1930s that made both Graham and Dodd wealthy.
2. Perhaps because of the constraints of a one-hour class, we were instructed to disregard inventories in our valuation and the recalculation of book value when restructuring balance sheets. This was a good first cut, but some finished product inventory had value. Also, debts could and were renegotiated to lower amounts. 
3. The third set of missing elements were the items not on the balance sheet. For example, long-term leases on valuable locations, railroad right of ways, new valuable products under development, immature customer relationships, physical and other location advantages.

In my discussion with the good professor, he discarded my questions related to growth. What I now realize is that he was essentially teaching a course on the use of accounting statements for investing. These are necessary, but insufficient.

Today, a price/book value or tangible value is a paper cover of a book, not the book itself. Far too many investment reports state the relationship without detailed analysis.

Positives

The largest positive is that we have probably been in a recession for all of 2022, and possibly longer. Months later, NERA will identify when the official beginnings of the recession. Regardless, time spent on the way down eats into the time in recession, which on average lasts 32.5 months or a median of 27.1 months. 

The JOC-ECRI Industrial Price Index fell -0.44% this week because port delays got shorter and container rental prices dropped.

Both biotech/pharma and electronic technology are on the verge of exciting new products. For example, Apple’s AR headsets could open a new stream of products. (Apple is owned in personal accounts.)

Due to China launching its fourth super-carrier, defense procurement spending will eventually rise.

What to Look For?

I don’t know yet, but these are some of the things I am looking for:

• Long-term survival skills. This means cutting some things to improve efficiency, but not a critical new product or service.
• Investing in the right client relationships
• Developing the right international friends
• Securing the right financial relationships.

Final Thought

Is there a timing connection between the extreme AAII bearish reading of 59.3% and the recognition we are in a recession?

Please share your thoughts for the next great investment idea.

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

https://mikelipper.blogspot.com/2022/06/are-markets-getting-too-far-ahead.html

https://mikelipper.blogspot.com/2022/06/pick-investment-period-strategy-weekly.html

https://mikelipper.blogspot.com/2022/06/mike-lippers-monday-morning-musings-how.html

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On The Way To The Bottom? - Weekly Blog # 730

                                    

Mike Lipper’s Monday Morning Musings

On The Way To The Bottom?

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

When amid a campaign with no predetermined finish, it is difficult to guess both the timing and the result. We are in that position today and the best we can do is guess. Generally, there are two approaches to guessing. The first is to evaluate past contests and the second is to focus on current conditions. I will briefly do both, including two surprising differences.

History

Each market and/or economic decline is different. Pundits use labels for stock markets, such as market phase, correction, and bear market. Economic declines are divided into cyclical and structural. None are tight descriptions, but are somewhat useful in describing what has happened, with some predictive value.

Stock Market Declines

A fall of 20% from a former peak is called a bear market, a decline of 10% is labeled a correction, and a smaller decline is called a market phase. The problem today is the three popular US stock market indices can each be labeled with a different name:

DJIA               -8.82%  =  Market Phase

S&P 500           -12.28%  =  Correction

NASDAQ Composite  -25.06%  =  Bear Market

The majority of the public and therefore politicians get their brief market news based largely on the DJIA. Securities distributors and thin staffed financial institutions use the SPX, while professional traders pay attention to the NASDAQ. No wonder there is confusion concerning the current state of the market and to some extent where it may go. Almost by definition, the greater the decline the sooner a bottom is reached. Long-term subscribers know that I often find the NASDAQ composite a better market predictor than the others two measures. The NASDAQ led both on the way up and down. The reason for this is the junior index having proportionally less passive (index) investors making specific stock judgements. 

If you accept this analysis, then we have reached the level beginning a bottom, as most bottoms occur after a 25% decline. Consequently, followers of the NASDAQ can start to believe the bottom for this market is in range. This view is backed up by the level of transactions on the NYSE and NASDAQ, plus the number of new lows for the week ended Friday. On a year-to-date volume basis, the NYSE is +6.98% and the NASDAQ -6.10%. Last week the number of new lows on the NYSE was 649, versus 1023 on the NASDAQ. (In analyzing the NASDAQ, it is important to recognize that technology stocks were the leading sector, both rising and falling. (In the long-term future, I believe “tech” stocks will be among the leaders, but not necessarily the same names.)

Cyclical or Structural Economic Declines

Cyclical economic contractions are much more frequent than structural changes. Typically, cyclical contractions are caused by excessive money supply growth, which leads to too much borrowing and inflation. 

Symptoms 

We are currently experiencing those symptoms. The M2 measure of money supply growth is currently +13.21% on a year-to-year basis, which clearly includes what politicians call stimulus and I call political bribes. Not surprisingly, this has led to the JOC-ECRI growing +17.37% this year. (The good news is the index dropped 1.51% this week). Consequently, it is reasonable to speculate a recession is in our future.

The critical risk is political leaders transforming a cyclical downturn into a structural one, as they did globally in the 1930s. This is not a prediction, but as a trained US Marine I am always alert to a sneak attack and need to be aware of the risk. There are currently an unfortunate number of parallels with the 1930s. Despite a general economic expansion globally, there is a vocal minority that can be leveraged by politicians (Remember, I believe Mark Twain said the job of a politician is to find a parade and get in front of it). 

Current leadership is becoming more autocratic in several countries. Small regional wars have the potential to become global wars e.g., Ukraine>>>Black Sea >>>Asia Minor >>>>East vs West?.

The French Presidential election demonstrates much of the population votes against. This election conforms to the view that there are almost no popular governments, just more popular than the opposition. This in turn makes long term plans difficult, which in turn also makes investment judgements difficult.

Question: What do you think?

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

https://mikelipper.blogspot.com/2022/04/short-long-term-thoughts-weekly-blog-729.html

https://mikelipper.blogspot.com/2022/04/is-this-great-investment-era-ending.html

https://mikelipper.blogspot.com/2022/04/wwiii-slightly-delayed-bear-market.html

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Does the Decline Influence the Recovery? - Weekly Blog # 723

 Mike Lipper’s Monday Morning Musings

Does the Decline Influence the Recovery?

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

Positioning

As a contrarian I am comfortable sharing my view of the market with the majority. Sharing this view is not done to stand out among a crowd of students of the market, but to attempt to position myself and the accounts for which I hold myself accountable. Over time, the rate of return earned by the majority is less than some of the minority, who happened to be right for some reason. With that thought in mind, I will try to focus on the recovery from the predicted downslope we are in, looking across the unknown valley to the beginning of the recovery.

Where are We?

As is often the case, there are conflicting trends. In terms of stock prices, we are in a decline. Until it is finished, we won’t know if the decline is just a trading event, a correction, or a bear market. The media makes a distinction, defining a decline of 10% as a correction and a fall of more than 20% as a bear market. Using the most popular market indices the picture is muddled, with the NASDAQ Composite well into the correction phase, dropping -15.9% from its January high and even more from its all-time high in November 2021. The S&P 500 has flirted with the -10% level. (Based on the present length of the market expansion and the nature of changing stock leadership, I believe that we are heading for a bear market.)

The broader economy is also showing disturbing signs. The JOC-ECRI Industrial Price Index rose 2.8% last week and is up 31.3% for the year. January’s backlog data was up +19.6%, with the number of new orders up only +6.8% and non-durables up only +5.6%. In February, before the Ukrainian invasion, purchasing orders were down -3.8%.

“Buy the Dip” Advocates May Get a Bad Bounce 

This week in Seeking Alpha there were four different recommendations to buy shares of T. Rowe Price (a stock owned in both personal and managed accounts). I have had the pleasure and honor of meeting with all the firm’s Chairmen, going back to Mr. Price himself. I hope my heirs continue to hold these shares, although much like Berkshire Hathaway, I have concerns about a potential change in the shareholder base. The difference is price action may be signaling a long-term change in the valuation of the stock. The low price this week was $137.76, a long way from the 2021 high of $220. What is a bit more worrisome is the $137.76 low on Friday, on 2 million shares of volume. The high for the week on Monday was $145.11, on 1.6 million shares of volume.

I reviewed four recommendations of T. Rowe Price which touted the remarkable financial record of the firm and concluded the stock was a buy. I hope they are right; however, like most current recommendations to buy Berkshire, they dwell on history. When a stock drops by 1/3 and the “market” hasn’t fallen much, it raises questions as to the repeatability of the record. Clearly, if the record is repeated the stock is a great long-term buy, but if not repeated, it will disappoint shareholders staying on board. I have not read any reports questioning the long-term vitality of T. Rowe Price; however, I could dream up some worries that could cause disappointment if they turn out to be correct. 

The following is a brief list of issues that could go wrong in the future, which the firm has not dealt with in the past:

1. Private Equity and Private Debt have been important contributors to the gains in many of the firm’s funds and accounts. Almost every investment manager is fielding similar products. With so many firms raising money in the markets for “privates”, the purchase price demanded by entrepreneurs will undoubtedly rise, while about half of the privates offered to the public through IPOs declined in the “after-market”. One clue this phase may be coming to an end is the SEC demanding more disclosure from this sector. (Nothing like the Police showing up after a crime is committed.)
2. There is a trend of financial intermediaries merging into larger organizations. At some point the larger intermediaries will demand a bigger slice of the profits of the account.
3. Governments are concerned about a large portion of the voting population still without any, or sufficiently large, retirement packages.
4. With more pressure from clients or their agents, fees may come down, regardless of inflationary increases cutting profit margins.
5. An activist government may force advisory firms to go into less profitable businesses.
6. Some large settlements may be awarded by activist courts.

I believe the current management is aware of these and other risks, but bad things can happen to all of us.

Question?

What are the non-present risks that could hurt your investments?  

  

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

https://mikelipper.blogspot.com/2022/02/successful-investing-expects-unexpected.html

https://mikelipper.blogspot.com/2022/02/we-are-progressing-weekly-blog-721.html

https://mikelipper.blogspot.com/2022/02/building-long-term-investment.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Two Critical Questions: - Weekly Blog # 717

 

Mike Lipper’s Monday Morning Musings

Two Critical Questions:

I.  Can Performance Replace Diversification and Create Too Much Risk?  

II.  Is January 2022 the Beginning of the Bear Market?

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

Are the Answers Linked?

The youth of today, with all their expensive schooling, are at a distinct disadvantage. They have not studied ancient history or the leaders and common people living through those periods. In their limited time, if they could study just two periods, they might find relevant answers to questions with implications for today. The development and collapse of the Roman Empire and some of the structural causes of WWI. 

As this is an investment blog, I won’t teach history in detail. The following is a list of historical topics with significant implications for today. They may help answer the two questions asked:

1. The tension between a divided Roman Senate and the leadership of the strongest state in the world.
2. The most technological roads and viaducts also helped weaken defenses.
3. The rising costs of “gifts to the people” became necessary bribes, reducing military spending.
4. While a lose collection of German tribes eventually ran over Rome, they could not agree on how to govern their conquest.
5. Compared to the cohesion of other European countries, Germany was late in unifying and did not have nearby land to grow.
6. The Holy Roman Empire, based in Vienna, was structurally weak.
7. France lost 25% of their young men in the Franco-German War, the most productive people in their country.
8. Making the loser pay for the winners’ costs through reparations failed, and in so doing ignited global inflation, leading to many autocratic governments, including the US.

The Positive and Destructive Power of Performance

(Historical Notes: In the mid-1960s, I was one of the very few securities analysts focused on what were called conglomerates. As an analyst, my research I sold to financial institutions, largely in the US, but also in the UK, Continental Europe, and Canada. Consequently, I became conscious of multi-industry companies in their countries too. My early analysis focused mostly on US auto parts and bicycle parts manufacturing companies, then gravitated to electronics companies, particularly those with defense and aircraft applications.)

From the beginning of recorded history, the danger of relying on a single or a few similar clients was clear. (Shakespeare’s “The Merchant of Venice” demonstrates the risk of a merchant’s wealth being tied up in a single voyage.) To avoid such risks, the more enterprising merchants evolved into merchant banks, with multiple clients in multiple trades. Famous Scottish trusts developed investment vehicles for the wealthy and lower classes, investing not only in voyages, but also in a wide array of stocks and bonds. They paid attention not just to investment performance, but also to the longevity of their businesses.

A handful of Boston Law firms began as custodians for the wealth of ship captains on their Asian voyages. They developed documents hoping to limit the risk of total disaster by minimizing the risk in stocks, investing the remaining assets in supposedly super-safe bonds. It was out of this colonial heritage that Boston based firms developed the first US mutual funds, utilizing their successful Balanced Funds business.

The Boston law firms had their own security analysts and portfolio managers until at least the 1960s. Their legal documents proscribed diversification rules to lower the risk of total loss during hard times. Thus, the need for diversification came into usage in the institutional asset management business and appealed to insurance companies who had similar rules.

The Problem with Two Asset Type Diversification

If the two asset types were totally uniform, one could control the risk of large losses. Losses were significantly reduced by requiring the investment of 60% in stocks and 40% in bonds, at cost. While this worked for the lawyers and their naïve clients, security selection remained a risk. Including the selection from among so-called “high-grade” stocks and bonds of different maturities and liquidity. 

Asset managers whose customers were primary interested in upside performance found the restraints too limiting, particularly during periods of inflation. To get a more appropriate measure of fund risk, I tried to group funds taking similar risks. By the end of the 1980s my firm had created over 100 separate peer groups for performance measurement purposes. There are probably an unknown number of new peer groups that would be useful today.

When I privately compare funds, I go beyond just security selection. Among the things I look for are:

• Portfolio turnover
• Whether the portfolio is collegially managed or has a single decision maker
• The size of the firm’s research effort
• Tax management
• The historical recognition of losses
• The availability of back-up people
• Trading and administrative skills available within the group

All these measures are useful in reducing investor risk. However, better relative performance in one segment can diminish the power of diversification in limiting risk.

Where Are We in 2022?

While we have only experienced three weeks of the new year, we have been confronted with a very different market and performance environment. With a lot to identify and interpret, I am using fund performance as an intermediate filter to examine what is happening. I’ve observed meaningful changes, raising questions about the normal desire to extrapolate past performance trends. I find the following significant:

1. Through Thursday, with Friday having an additional significant loss, most fund peer groups experienced single digit losses. The sole double digit loss was the e-commerce business.
2. The very few US registered mutual fund gainers have been international funds, with strength in emerging markets, commodity funds, and global energy vehicles.
3. Large-Caps have fallen less than the smaller-caps, suggesting larger-caps have earned a liquidity premium.
4. The average stock in the broad indices is down considerably more than the relevant cap-weighted index.
5. JP Morgan released a study of thematic fund performance, which was no better than the general market measures.

What Does the “Tech” Correction Mean for the Future?

(Remembering that the sole function of fluctuating markets is to produce humility in the survivors, and my assertion that I can and will be wrong, there are reasons to be concerned.) The history of peaks and bubbles shows good performance in a small minority of traded issues at the top. The good performers, in this case a limited number of large-cap tech stocks, have drained dollars out of the rest of the market.

As readers know, I view moves in the NASDAQ Composite as leadership in the entire US market. From its all-time high, the index is down 14.5%, clearly a correction. I believe the Russell 2000 is in correction as well. At some point, I guess the more senior measures will close the gap with the NASDAQ. The interesting thing is the size “off” volume at the NYSE and NASDAQ are about the same.

I have been concerned about the underlying economy showing some disturbing signs:

1. The lowest interest rates in 5000 years, until the Fed’s future small moves. The adjustable mortgage interest rate is showing some contrary trends e.g., the 3-year rate rose 12 bps this week, vs 3 bps for the 20-year.
2. Capital expenditures are being spent on supply issues rather than “greenfield” expenditures. This is indictive of a lack of confidence in the longer-term future.
3. China is having problems with a peaking workforce, although its currency is rising against the dollar.
4. The US stock market is being driven by shorter-term players, with more volume in ETFs than the more retirement oriented conventional mutual funds.
5. There is a significant trend of bank branch closures. I expect to see more retail mergers and growth in crypto-currency vehicles. The average young person has much less cash than we did at a similar age.
6. A focus-group of independents who each voted for both Biden/Obama and Trump, are concerned about crime and the way the current economy is being managed. With worries about the future, these concerns could lead to a consumer-based recession. (With rare exception, there is not a popular political leader globally, although the opposition currently lacks much support.)
7. The National Science Foundation published a report on the state of US Science & Engineering. the report shows the US losing leadership to Asia (China, Japan, and South Korea), measured in dollars expended. Considering wages are less in Asia than in the US, the Asians may be getting more for their money.

Working Conclusions

If the correction in capital-intensive Tech and Health companies accelerates, it could cause an overall decline in the stock market. Much like in the run-up to The Depression, it could cause some consumers to cut back their spending, leading to a consumer recession. It doesn’t have to happen, and the timing may be uncertain, but based on the subjects not being taught, the odds favor it. 

  

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

https://mikelipper.blogspot.com/2022/01/current-causes-of-concern-weekly-blog.html

https://mikelipper.blogspot.com/2022/01/deeper-thoughts-weekly-blog-715.html

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

Did someone forward you this blog? 

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.