Dead Cat Bounce > Last Chance - Weekly Blog # 952

 

 

 

Mike Lipper’s Monday Morning Musings

 

 Dead Cat Bounce > Last Chance

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

 

          

 

We appear to be in a normal trendless summer, with relatively low volume on hints of fall upsurges and declines. This poses a big risk for

investors with large gains in their portfolios who could be subjected to major moves from stampeding investors selling for fear of a big decline or speculative surge.

 

I am therefore suggesting that this is the time to build cash reserves so that you are in a position to take advantage of large future declines. The trick is to have a reserve large enough to shelter the portfolio from meaningful losses, but small enough to protect against being out of the game following the next rise. The next decline could be major and last for a long time, which might encourage those who have too much cash to stay out of the game. That is the real risk facing careful investors.

 

My suggestion is to treat your account as a long-term pension or endowment account with annual flows of about 10%. This would require a two-year buildup of short-term cash reserves under normal investing conditions. This suggests a target equity commitment of 70%, with a short-term reserve of 20% and an emergency reserve of 10%. The key to this strategy is avoiding a down market that reduces the equity commitment below 50%. One way to accomplished this is to begin an orderly reinvestment program in the declining market.

 

Reasons for Concern this Week

• The Consumer Confidence survey fell to 50.8% vs the expected 52.4%.
• Estimated GDP for the second quarter came in at +1.5%, below the estimate of +1.8%.
• Chinese tech stocks fell -8.6% in July. On Friday, Apple (personally owned) fell -7.4% on rising earnings.
• Barron's 10-year high grade bond yields slipped -0.03% while yields on 10-year mid-quality bonds rose +0.04%. (The bond market is more concerned about the future of the US Government and the currency than commercial credits.)
• There were 286 new highs and 189 new lows on the NYSE, versus 468 new highs and 692 new lows on the NASDAQ*. Suggesting there is presently more opportunity in industrial and financial stocks on the "Big Board" than tech-driven stocks on the NASDAQ. (*NASDAQ stock owned in managed accounts and personal portfolios)
• Warren Buffett is quoted as thinking the market is gambling, not investing. (In the past his general warnings have proven accurate.)

 

What Do You Think?

 

 

 

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Mike Lipper's Blog: Long-Term Money Via Telescope, Not Microscope - Weekly Blog # 951

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Mike Lipper's Blog: Little Occurred During the Trading Week - Weekly Blog # 949

 

 

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Bifocal Analysis: Short & Long-Term - Weekly Blog # 933

 

 

 

Mike Lipper’s Monday Morning Musings

 

Bifocal Analysis: Short & Long-Term

 

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

 

 

 

Short-Term

The data is so negative that brief and violent rallies are to be expected. Net stock selling has consistently outpaced buying for each of the last four weeks. For example, 85% of the NYSE stocks and 81% of NASDAQ stocks fell in the latest week. As Barron’s noted “cash is looking more appealing since stock market hedges, bonds, and gold are no longer working.” Employers are barely replacing the more expensive retiring labor in most manufacturing functions.

 

There is a new player in the game, private credit. For the most part issuers of private credit instruments don’t qualify for bank loans, and they don’t have long credit histories either. Much of this paper is held in new funds, which are being sold to retail channels. When one of these loans gets in trouble it is referred to as a “cockroach”. Jaime Dimon, the CEO of JP Morgan Chase (*) warned that where there is one “cockroach” there is likely to be more.

(*) JPM shares are owned in managed accounts.

 

Market analysts are concerned that the S&P 500 Index has been locked in a narrow 300-point band for the last four months, with optimists and pessimist exchanging positions. This week, the lower boundary line was briefly pierced. If the “500” drops 3% more, then the 400-point range will become a difficult region for the market to rise beyond for quite a period. This fear may briefly spark some rallies from the derivative and short players.

 

Longer-Term Implications of History

One purpose of recorded history is to explain what happened, at least in the eyes of the winning survivors. The survivors, or their intellectual heirs, construct rules as to why certain actions are repeated. If there are enough repetitions the rules become dictum, even though the battle conditions are different. We are taught from a very early age to follow rules without an understanding of the conditions that created them. This blind acceptance of rules has led to occasional great mistakes in politics, the military, sports, families, business, and of course investing. Historic labels often become shorthand for rules. For instance: Adam and Eve, George Washington, the NY Yankees, Democrats, Republicans, Chopin, etc.

 

As has been noted before, I learned basic analysis at the NY racetracks. One great lesson from racing lore was Man of War, which had 25 winning races in a row but lost his last race to an unknown horse named Upstart. Proving unexpected things can and occasionally do happen. My self-appointed task at the track was to guess the chance of the unexpected happening.

 

Applying the racetrack experience to investing I looked at the historical record of Warren Buffett and Charlie Munger for stocks and companies in which to invest. In an oversimplification there were at least three characteristics the winners had in common, the nature of customers, the characteristics of the workforce, and the discipline of integrity. (I suspect the last was penned by his long-term counsel and director Ron Olson, a fellow ex-trustee of Caltech.)

 

If the US stock market does decline materially in the period ahead, I will try to apply the track lessons learned. Charlie Munger taught Warren Buffett it was better to buy a good company at a reasonable price and not wait for a cheap price. For many years there were great companies we didn’t own because they were selling way above a reasonable price. I expect a number of these “beauties” will be available at reasonable prices during the next depression.

 

Next Depression

I don’t know when it will happen but based on human nature, I expect it to happen. The US has had only four Presidents that were restructurers: Andrew Jackson, Teddy Roosevelt, FDR, and Trump. Below are some parallels to the 1930-1942 depression:

• Each challenged the constitution and fought with the courts
• Weakened the controls on the banks
• Set the stage for war
• Weakened the currency
• Encouraged the retail public to invest in speculative vehicles
• Changed how the US was governed
• All Presidents, except Andrew Jackson, were involved with Japan

No historical comparison is identical, and the future may be different than the past, but odds favor a closer similarity.

 

Please share your views, there is much to learn.

 

 

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Mike Lipper's Blog: This week’s Dichotomy/Bifocals Needed - Weekly Blog # 932

Mike Lipper's Blog: Premature: Buying Program to Begin Soon? - Weekly Blog # 931

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

 

 

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Risks Are Rising Thru the Clouds - Weekly Blog # 915

 

 

 

Mike Lipper’s Monday Morning Musings

 

Risks Are Rising Thru the Clouds

 

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

 

 

 

Overview

There does not appear to be a clear unified picture of the near-term future for the next couple of years. In examining a number of separate and distinct elements, each with their own limited cloudy outlook, I see a growing level of disconnected risks. Hopefully our intelligent subscribers can sense a positive future and share it.

 

Topics of Concern (In no meaningful order)

• The price of gold and crypto elements are rising, with the exchange value of the dollar falling more than 10% earlier this year. For centuries the single greatest attraction of gold was at the coin level, with the ability to bribe one’s exit from one country into another. Today, I am unaware that this is a major demand contributor. The Central banks appear to be the largest buyer, replacing some of the depreciating value of their large dollar holdings. While that might serve a few countries well, there is not enough gold in the world to fill all needs at any reasonable multiplier of current gold prices. Crypto also seems to be potentially price limited. At the moment I do not see any move by major countries to be a substitute replacement for the dollar.
• While the Chinese currency is now the third most used currency for world trade, I do not see any willingness of that government to use its currency for anything beyond its own trading. They do not want their currency to trade freely and absorb the turmoil of other countries.
• I do not see crypto as an alternative in size, particularly if it is US dollar based. Both gold and crypto don’t have a large industrial use, unlike silver to some degree.
• One possible substitute for the dollar is copper, and possibly some other base metals. One new problem for Dr. Copper is the expected increase in use by “AI”. It is interesting to note that Base Materials (Metals) were the second best performing mutual fund category in the current week (+4.44% vs -2.70% for the worst fund category Global Science & Tech.)  It may be worth noting that the ECRI industrial price index went to 115.50 from 114.80 the prior week, even though it does not normally move much.
• A significant number of casualty insurance companies have invested in private debt vehicles with limited liquidity.
• The weekly 6-month forward looking AAII sample survey found only 31.6% bullish and 49.1% bearish compared to three weeks prior, where the readings were 44.05% bullish and 36.9% bearish.
• In the current week there were more decliners than gainers on the NYSE and NASDAQ.
• A number of economists have noted that the top 10% of the population, often over 75 years old, own 50% of US wealth. The bottom one third, those who are 35 years old or younger, own 10%. (This may well explain the results of the only two governor elections this year.) This formation is being called “K shaped”.

 

I appeal to our readers to contribute your good thinking regarding the importance of these elements and to let me know how it affects your view on the global stock and money markets. 

 

 

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Mike Lipper's Blog: The Inevitable Recession - Weekly Blog # 914

Mike Lipper's Blog: Biggest Investment Hurdle: Complexity - Weekly Blog # 913

Mike Lipper's Blog: Signals of Change in Historic Patterns - Weekly Blog # 912

 

 

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Investors Not Traders Are Worried - Weekly Blog # 856

 

Mike Lipper’s Monday Morning Musings

 

Investors, Not Traders, Are Worried

 

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

Investors are concerned that their US dollar capital could be insufficient to completely fulfill their important responsibilities. Not all their concerns will be successfully addressed, many of them will likely continue to be problems for capital owners and beneficiaries. A short list of the visible problems follows in no particular order:

1. The number of voluntary and non-voluntary retirees is growing in many developed western countries. They are growing faster than the number of workers eliminated by “AI’s” future impact. In the US today there are four workers for every retiree. It used to be nine.
2. The American privilege of having the most valuable currency is fading. One Presidential candidate wishes for a lower value, while both advocate for disguised inflation that will reduce the value of US currency. This will lead to higher interest rates on debt sold to overseas buyers.
3. One of the ways the wealthy protect themselves is by reducing cash holdings in favor of investing in various forms of art. “The Art Market Is Tanking” according to WSJ’s front-page article on auction prices and volumes.
4. Increasingly, investors and corporations are using exports and foreign investments to escape local regulations and taxes. Globally, 128,000 millionaires plan to move their domicile in 2024.
5. The Fed’s reduction in interest rates is unlikely to lead to a “soft-landing”, unless fresh capital is invested in plant/equipment.
6. Forty three percent of the stocks in the Russell 2000 are unprofitable. Unless the contemplated government grants to new start-ups is run by the SBA or a similar agency, it will lead to large scale losses of family and friends’ capital.
7. The CFA Institute conducted a survey of 4000 CFAs regarding their current view of the market/economy. The findings which will be published shortly are distinctly negative in terms of their outlook. (CFAs earn their designation by passing three rigorous academic type exams. It is worth considering that 4000 CFAs responded to the questions, compared to roughly 1000 in various WSJ and other polls. While there are a number of CFAs that work for brokerage/investment bankers and hedge funds, I guess over half the poll participants work for financial institutions. Most of their clients are more long-term oriented than the clients of many brokers, investment bankers, and hedge funds.)

                                                                                             

Hopefully these views will raise questions and disagreements that subscribers can share with me.  

 

 

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Mike Lipper's Blog: Many Quite Different Markets are in “The Market” - Weekly Blog # 855

Mike Lipper's Blog: Implications from 2 different markets - Weekly Blog # 854

Mike Lipper's Blog: Investors Focus on the Wrong Elements - Weekly Blog # 853

 

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Rarely Found Different Thoughts - Blog # 757

 

Mike Lipper’s Monday Morning Musings

 

Rarely Found Different Thoughts

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

            

 

 

Unexamined thoughts can contain time-bombs antithetical to generally accepted views. Good professional scouts (analysts/portfolio managers) should review as many unexamined thoughts as possible to find comfort in their present views, or look for possible reasons to change them.

The closer you focus on media designed for mass audiences the smaller the focus on detail. This results in more emotional and decisive views. The conclusions might end up being correct, but the historical odds of being right are substantially below half.

A good example is the reported percentage gain from the June lows for the 3 popular stock market averages. Most of the media, with their limited space and time, tend to focus on the results of the 30 stock Dow Jones Industrial Average (DJIA). You get a distinct happy view that this senior index is up +14.40% from its low point, which is in the mid-range for rallies after a sizable decline.

A much larger sample found in the S&P 500 index, weighted not by price but by market capitalization, has gained +9.05%. This is a more normal sized bounce, not the large gain seen in the DJIA. Considering this index is experiencing a period of increased volatility and is only up 353.44 points, it seems more like a rally in a traditional “bear market”.

Tech-oriented stocks led global markets both in the last expansion and during the most recent decline. There were some notable near-term declines in earnings and or future guidance, yet their prices increased +6.58% as measured by the NASDAQ Composite. The sectors that go down most in a short-term market rally often lead on the upside too. No so now!!

The problem facing the world in terms of chatter by politicians and pundits is inflation. People don’t understand that inflation is a price adjustment mechanism to equate the value of goods and services to the currency at hand. Inflation is a measure, not the cause. It is created by perceived shortages, not excess demand. The shortages are partially caused by the declining productivity of human and financial capital.

The collective failure to address these causes suggests one should take a bearish attitude in anticipation of a probable recession. The real fear is that without addressing the real problems we will experience future deeper recessions, stagnation, or worse for capital owners, stagflation.

How do you see it?

 

 

 

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Mike Lipper's Blog: Current and Future Views are Confusing - Weekly blog # 756

Mike Lipper's Blog: Fundamental Changes Occurring - Weekly Blog # 755

Mike Lipper's Blog: Are We There Yet - Weekly Blog # 754

 

 

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Questions Without Answers Indicate Uncertainty - Weekly Blog # 712

 

Mike Lipper’s Monday Morning Musings

Questions Without Answers Indicate Uncertainty

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

Searching for Direction

Investors gain confidence when they have a clear sense of direction, particularly regarding short-term market moves. They ask a lot of questions in the hope of finding concrete answers. This is increasingly true as markets move closer to the top of a major phase. Thus, extreme confidence, while generally reassuring, is a warning sign of a nearby top. 

Each week I examine lots of data and articles in the media looking for concrete answers, or at least a guide as to direction. This week I came up with some interesting questions, without any good answers. As many subscribers are professional or insightful individual investors, I will serve up the questions with elements of my indecisive views. I am hopeful some will provide answers as a Christmas present and communicate them to me, either for my personal use or to share.

Are Smarter Investors Calling a Turn?

For some time, I have suggested large investors in the NASDAQ stock market are on average brighter than those invested exclusively or mostly on the New York Stock Exchange (NYSE). This is based on the performance of various small-company mutual fund portfolios trading on the NASDAQ since the March 23, 2020 trough. On average this has been the best performing group based on market capitalization (The other groups are large-caps, multi-caps, and mid-caps.) However, year-to-date smaller caps are running in fourth place. There was possibly a change on Friday with its high volume? The NYSE volume was 5 million shares, split roughly 2 million on the upside and 3 million on the downside. On the NASDAQ, total volume was close to 8 million shares, split 4.6 million shares on the upside and 3.2 million on the downside. The NASDAQ Composite has declined 5.53% from its 2021 peak, the most of the three popular indices and roughly halfway through a classic 10% correction.

Does Friday's market action suggest savvy players picking up bargains at low prices?

Commodity Funds Rising Earlier than Expected

Numerous individual commodities are rising due to shortages. The median commodity fund is up +28.79%, while the weighted average fund is only up +3.92%. The reason for this difference is the extreme performance of Energy funds +71.98% and Precious Metals funds -10.41%. Commodity price cycles typically extend to one or more decades, for example from 1996 to 2016. Professional commodity investors did not expect a general commodity rise for at least another five years, after several new mines became operational. The switch to electric vehicles from internal combustion engine vehicles has accelerated demand for some metals, while the interest in currency coins has simultaneously impacted the demand for numerous commodities.

Are these speculative trends going to continue and cause actual mine and mill openings to accelerate? 

Investors Are Finding Other Markets Attractive 

While the US equity market has gained about 25% year-to-date, three other markets are also up over 20%:  India +22.3%, Taiwan +22.0%, and Canada +21.5%. Many investors now see international diversification as prudent, with political turmoil making US investing difficult for at least the next three years. As the economy recovers from various pandemics and tax/trade uncertainties, declining percentage gains in rising earnings will hurt. 

The Fed is Not Helping 

The Fed is basically defining its role as affirming the current situation by looking forward from its present position.

Critical Question: Do you think you will change your investment strategy materially before the next top?

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

https://mikelipper.blogspot.com/2021/12/two-contrarian-questions-next-recession.html

https://mikelipper.blogspot.com/2021/12/selections-weekly-blog-710.html

https://mikelipper.blogspot.com/2021/11/investors-be-alert-to-novembers-risk.html Mike Lipper's Blog: 

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Our Investment Mistake is in Labeling - Weekly Blog # 582

Mike Lipper’s Monday Morning Musings

Our Investment Mistake is in Labeling

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

Mixed Results Change in Focus
While the S&P 500 went to a new record high on Friday, it and the other major stock indices closed down. This is both good and bad news. Investors were not sucked into the market, which confirmed their growing concern for future growth. Currently, many pundits are expecting the same, both in the slower growth of GDP and earnings per share. That is the bad news. The good news is the current lack of enthusiasm for stocks. The reason that this is good news is that often the final phase of a "bull-market" is wild enthusiasm for a subset of the market, which in turn drives the bulk of the market higher. This has not happened-----thus far. Also, more and more analysts are recognizing the deterioration of quality in credit instruments, including CLOs. With these concerns present, now is a good time to examine one's asset allocation. However, this should be done in terms of the intended use of capital, not as is more commonly done by asset class. Purposes are more useful than instruments.

Segmenting a portfolio
We learned long ago that a good way to avoid large losses is to divide our investment efforts into different parts that have different characteristics. The mistake that most make is labeling the diversified parts by asset class e.g. stocks, bonds, real estate and commodities. These labels are too broad and do not suggest their intended portfolio use. Each of the labeled asset classes can be used aggressively or conservatively in terms of intended risk and reward.

The investment spectrum
I suggest that a single spectrum is more useful in building a successful portfolio. This spectrum incorporates the long-term movement of capital, from preservation to appreciation. Every investment is likely to have elements of both capital appreciation and capital preservation; however, at any given time one characteristic is more prominent than the other.

The Prudent Man Rule
If one thinks about the prudent (man) rule that Judge Putnam issued against Harvard in 1830, he was ruling based on what other intelligent men (thus the Prudent Man rule) used in their own affairs. (The judge did not recognize that men, while they may have been the ones transacting, needed to include the desires and wisdom of women in the decision-making process if they wanted a harmonious family life.) What the judge recognized was that different mixes of assets and liabilities produced different results and it was imprudent to rely on a single type of investment.

Betting on an uncertain future
In looking at my personal portfolios of assets, liabilities, and identified responsibilities, I try to group investments in terms of capital appreciation and capital preservation. I do this recognizing my inability to predict the future accurately, as life is full of surprises. This is where my analytical training at the racetrack shapes my thinking. Most money bet on a race is on the horse that appears to have the best chance based on prior success. The problem with this is that the pay-off odds are low and the winnings are insufficient to cover prior losses, unless a great deal more money is bet on the favorite.

While we all celebrate the story of a single-minded inventor betting all on a single invention, we realize that the chance of finding this magic are extremely low. This may well be the cause of my being a contrarian, rather than it being a personality failure. Thus, in my mix of capital responsibilities, my investments are spread out along the expectation line.

Considerations for capital preservation
Judge Putnam did not take into consideration the fluctuating levels of inflation and currency movements we face in the modern world. Capital preservation is not maintaining a specific number of dollars, pounds, euros, or yen, it is maintaining the financial ability to meet a standard of living that is appropriate. Thus, capital preservation stocks and funds are based on expected spending levels. In my own thinking it covers the cost of healthcare and education. Several investments in my capital preservation portfolio are in well managed, secular growing companies, often paying a predictable dividend. Over an investment cycle I expect this portion of the portfolio to do slightly better than average, mainly because it will go down less in periodic down markets.

Considerations for growth
Capital Appreciation stocks and funds are expected to add to our wealth over time and should generate growth above the expenditures inherent in the capital preservation portion of the portfolio. These investment vehicles can only accomplish this mission by entertaining more risk of capital loss. Over a limited number of investment cycles, capital appreciation stocks and funds should lose no more than 50% of their beginning value and should multiply their starting levels two or more times.

When one examines an investment vehicle, I hope you can see the combination of capital appreciation and capital preservation qualities inherent in each investment. Further, I hope your portfolios will have your own appropriate mix of capital.   

How to Apply Capital Allocation
Making precise judgments about the future is probably impossible, but making judgments about the relative growth of capital and volatility is easier. I am sharing my thinking, not as a recommendation to follow, but as an example of how to assign relative probability to your holdings.

In terms of capital appreciation I have identified BYD, a Chinese auto manufacturer which produces the largest number of electric cars in China and has a contract to provide buses in Los Angeles. Furthermore, its chairman is busy working on other transportation products and services. These characteristics and developments, added to the cyclical nature of auto sales, suggest that reported earnings will be erratic for a while. Nevertheless, the possible potential is intriguing. A more diversified approach to capital appreciation would be mutual funds that focus on innovation and discoveries.

In terms of capital preservation, I use Berkshire Hathaway. It has built a portfolio of private companies and publicly traded securities designed for the heirs of Warren Buffet and Charlie Munger, as well as for a considerable number of their shareholders. One could also include the Rothschild Investment Trust, traded in London as a somewhat similar capital preservation vehicle.

Question of the Week:
What have you identified as Capital Appreciation and Capital Preservation vehicles for you and your accounts?
     

     
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/06/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2019/06/on-right-learning-from-left-weekly-blog.html

https://mikelipper.blogspot.com/2019/06/confidence-deteriorating-normally.html



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Implications of China vs. US Timespans

Introduction

A number of years ago a good friend attended a Chinese Embassy party where a very senior member of the government commented that while the West owned the watches, the Chinese owned the time. This critical distinction has stayed with me in terms of looking at investment horizons.

One Belt One Road

While there has been some US coverage of the “One Belt One Road” meeting in Beijing this Sunday hosted by Xi Jinping with Vladimir Putin in attendance, most of the US attention has been focused on the dismissal of one employee at the discretion of the President. As a long-term investor, I believe this is a misplaced focus. On the Chinese side the implications of the massive One Belt One Road Initiative may have implications into the next century. The US focus appears to be on the electoral contests in 2017-2020.

I find it is interesting that China is using a staging investment philosophy somewhat similar to our TIMESPAN L Portfolios^®. China announced some of the outlines to this the One Belt One Road Initiative in 2013. From an economic vantage point it was a brilliant way to export its excess steel and cement capacity in building long line railroads and some internal subway systems. It also would reduce shipping costs of Chinese manufactured products that potentially could be exported to 60 countries, part of the land and sea bridges.  This is somewhat like President Eisenhower's US interstate highway building program that required new federal highways to be built with the ability to handle the transportation of heavy tanks.  As the rail and port facilities are built, China (even without moving its military) will have strengthened its ability to influence all of the surrounding countries. Some have called this drive as "Globalization 2.0.” Compared to the Russian leader in attendance, the US is sending a senior director for Asia at the National Security Council. While there is definitely a military threat in this initiative, by far the bigger threats are economic and political.

The One Belt One Road Initiative is not without substantial  risks. The planned funding requires a series of public/private partnerships. Every analyst and most investors should have knowledge and respect for past histories. Around the world in the last half of the 19^th Century, there was a surge of railroad building. The British were particularly active in South America. I suspect that almost every railroad company started during this period eventually went bankrupt. In one case the largest and most powerful UK merchant bank almost went under because of its Latin American exposure. I can not think of a long line US railroad that did not enter or threatened to enter bankruptcy. Some of the same problems exist today. One of the Chinese-backed African rail lines is not expected to reach breakeven for the first eleven years, and we all know how reliable the predictions of breakeven have been. 

If we of short memory fail to remember the global distribution of less-than- healthy US residential mortgages, we could have a replay with global distribution of private partnerships through the growing power of Chinese financial services companies. Thus, for the global investor there is both downside and upside as this initiative grows. I maintain that no matter what you invest in; stocks, bonds, commodities, real estate, currencies, or intellectual property, your returns could pivot on what is happening or rumored to be happening in China.

What are the US Markets Focused On?

Investors into the US market are focused on the very short-term to intermediate future while China is exercising its long-term options.

The following are briefs tidbits that have crossed my computer screens this week:

1.  Dow Jones Industrial Average - A minuscule decline closed on of the two price gaps in its current chart. The other two major stock indices, S&P 500 and NASDAQ, still have price caps. (One wise market analyst suggests that we need a 5% decline before we can resume a meaningful upturn.)

2.  JP Morgan has noted that 37% of NYSE volume is executed in the last half hour of the trading day as Index funds rebalance.

3.  There is some justification in the adage “Sell in May and Go Away.” Since 1950, the period November through April does better than the other six months, 71.64% of the time.

4.  According to its inventor, the CAPE ratio, used as a valuation measure, explained about 1/3 of the variation in the ten year returns. (Surprisingly this is roughly the same chances of a favorite winning in most horse races.)

5.  Ray Dalio, who manages one of the largest hedge funds, sees no major economic risk in the next year or two. (This could be an important cautionary flag.)

6.  The highly respected GMO seven year prediction for real return on stocks is -3.8%

7.  Vanguard believes we are in a period of slow growth; e.g., a 60/40 asset allocation will produce a return between +3% and +4.5%. (If they are correct, which I doubt, the average foundation will be liquidating its base each year if it has a mandated 5% pay out.)

8.  Turning to the increasingly popular European investing, there are two points worth considering: (a) the current price of the Stoxx 600 Index is where past rallies have peaked out, and (b) over half of the ETF flows into non-domestic funds came into three Index funds and these were somewhat smaller than the ETF redemptions in two domestic Index funds. (These suggest to me that main players in the ETF market are trading-oriented, and may not be patient during surprises.)

Investment Conclusions

Despite the reputation of highly speculative retail Chinese investors, the Chinese government is playing a long game.

The US market is increasingly short-term focused. This may, over time, give us longer term investors a bigger barrel to fish in.

As we structure various markets I am wondering whether our assorted valuation measures need to be adjusted due to fundamental changes in supply and demand.

Any thoughts? 

__________

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Copyright ©  2008 - 2017

A. Michael Lipper, CFA

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Does Money Make the World Go Around?

Many of us are familiar with the song that begins “Money makes the world go round.” As a card carrying CFA^® charterholder and a recovering numbers cruncher, I will warrant that is how all too many measure the rotations of an individual’s, a business’s or a nation’s rise and fall through periods of net accumulations and net spending. However, strange for a numbers addict to say, I believe it is an incomplete and in many ways a faulty measure, particularly when considering investments.

Money=Currency

Money is an instrument of exchange used in buying and selling. In the modern world, money is expressed in terms of different currencies that can be transmitted physically over a sales counter or electronically through a banking system. As these exchanges are most often impersonal and rapid, we use numerical shorthand to represent the terms of exchange.

Money buys goods, services, and the time of others + what?

When we make purchases of physical goods most of us think in terms of the item; e.g., an auto or laptop. We do not consciously think of the hours and talents that went into producing it. We are somewhat more conscious of the hours and the credentialed talents when we purchase services from doctors, lawyers, accountants and perhaps paid speakers. We need to include into that list paid workers such as plumbers, electricians, and landscapers. One can easily put an immediate numerical value on a number of goods and services, particularly if there are competitors. However, most of what we buy today is not only for immediate consumption. Thus, there is an implied belief that the buyer is purchasing the goodwill of the vendor, but not in an accounting sense. The value of this goodwill is not just after warranties but entails the quality and quantity of thinking and effort that can make us better users of our purchases. The advertising industry has taught us that various purchases have an emotional benefit, like making us feel good about ourselves. This combination of goodwill purchased and the benefit of us feeling better are difficult to measure and can in the long-run be more important to us than initial price paid. I would suggest that these considerations make the valuation of cash more difficult than a bookkeeping exercise.

Cash/currency in your investment portfolio

I have just completed a couple days of visiting Portfolio Managers of different funds in accounts that we manage for both institutional and wealthy individual investors. In some respects the most revealing parts of these discussions were about the smallest part of their portfolios, the cash on their balance sheets. The different comments are as follows:

• “Cash is a residual after I make all the investments that should be made.”
• “Cash is awaiting a few more investments that are out of price range or are not fully identified or more analytical work is needed.”
• “Cash is a way to express a view as to the level of the market.”
• “Cash is flow management device.”
• “Foreign cash is a hedge against home currency.”
• “Cash is awaiting a planned sizeable redemption.”
• “Substantial cash holdings allow for riskier other holdings.”

I am sure as I talk with other portfolio managers I will learn of other points of view.

How do I use cash?

As indicated in earlier posts, I view my portfolio construction skills as more of an artist than a mechanical contractor. Carrying the analogy further I hope to be building estates, academic facilities, research labs, performance venues, medical facilities among other worthwhile activities. As each account is managed to meet different needs, my use of cash is far from uniform. The rhythm and timing of the account as well as the feelings about money are taken into consideration.

I use cash in a similar fashion as those that are listed above. Additionally, in risk adverse smaller balanced accounts I have used Treasury money market funds to avoid any principal loss. Currently, I am reducing this element in favor of ultra-short (duration) government funds and some short-term TIPS. My general attitude is that my clients should take their risk in the large equity portions of their portfolios not in fixed income.

If cash is trash as bulls believe, try ETFs

If I am a portfolio construction artist, the ultimate mechanically constructed investment product is the Exchange Traded Fund (ETF). One of the many reasons I believe actively managed portfolios should be compared only with other actively managed portfolios doing the same thing is as seen from the discussion above; i.e., active managers have varying amounts of cash in their portfolios. ETFs are designed to replicate the performance of a fixed list of securities. The list does not include any cash. Thus in a rising market all of the securities within an ETF portfolio could be rising in price. In an actively managed portfolio only the actively traded securities have the opportunity to rise (and fall), the cash is only a very small amount of income. Thus there is a tactical advantage in favor of ETFs. My clients believe that well-chosen selected investments will produce better strategic results.

What does your use of cash say about you?

Please share with me privately or publicly.

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Did you miss Mike Lipper’s Blog last week?  Click here to read.


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Copyright © 2008 - 2013 A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.