There Is an Incredible Shortage… - Weekly Blog # 648

 

Mike Lipper’s Monday Morning Musings

There Is an Incredible Shortage…

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

“There is an incredible shortage” How often do we read such headlines? Is it true or just a clever ploy of some marketer trying to move extra inventory? Historically, one of the better clues to the existence of rising prices is the number of global locations in which they rise. Nevertheless, in an electronically connected world one needs to be on guard against manipulation, or the new term spoofing, which is an effort to represent a larger supply or demand than actually exists. The very fact that prices are moving suggests, at least temporary, that there is an imbalance between supply and demand.

I submit that there is an unusual shortage of good stocks to buy. The shortage is global and cuts through different market capitalization sizes and is possibly ending. FactSet identified a group of companies that have both price/earnings ratios over 20x and returns on equity of 20% or higher. They then compared their performance for the latest three months and one-year, as shown below:

Name                 Number   3-Month   1-Year

S&P 500                        +19.87%   +6.91%

S&P 500 20/20           107    +20.16    +7.32

S&P 500 Ex 20/20        395    +17.56   -10.43

Russell 2000                   +22.92    -8.48

Russell 2000 20/20       73    +30.08   +16.42

Russell 2000 Ex 20/20  1889    +25.53   -14.19

MSCI EAFE                       -5.18    +2.40

MSCI EAFE 20/20          97    +21.50   +12.47

MSCI EAFE Ex 20/20      819     -6.75    +5.15

Clearly, high P/E and ROE stocks performed much better for the 1-Year period and a little bit better for the 3-Month period. Better individual stock performance carried performance for a number of mutual funds. Year-to-date through Thursday, of the 104 equity-oriented mutual fund investment objective averages I examine each week, only 26 gained more than the average S&P 500 Index fund’s return of +1.63%. And just 12 groups had double digit gains. The lack of many winners is one reason 17 IPOs could be sold this week, a number of which are not profitable and were never profitable.

Not Everyone Believes

Rising stock markets thrive on the conversion of cash and other securities into equities. This process is well known as the market climbing a wall of worries. For many would be stock investors, we have a surplus of worries. There is at least $5 Trillion of cash in investors’ brokerage accounts that could come in. Also, I believe it is only a matter of time before bond and bond fund holdings are converted into stocks, hoping to repair the damage done by future rising rates of inflation and interest rates. 

There are no perfect forecasting indicators for determining the direction of the stock market, although one of the best for determining the future direction of the stock market incorrectly has been a sample survey of the membership of the American Association of Individual Investors (AAII). Each week they ask a sample of their large membership where the stock market will be in six months. The replies are divided into bullish, bearish, and neutral decisions. Many market analysts count on these judgements being wrong. 

Surprise!! we “smart guys” have been wrong. For most of the summer over 40% of the predictions have been bearish, as is the current reading. In addition, bullish predictions are currently the smallest of the three choices. Perhaps the redeeming/selling holders of mutual funds and ETFs have been following the AAII predictions, as they were net redeemers for the last seven weeks. The more active ETF holders, which are often traders, have primarily been selling index funds rather than actively managed vehicles.

There Are Some Long-Term Bulls

A very large brokerage firm with many brokers acting as investment advisors believes that we are in the early stages of a long bull market, which began with the pandemic. Additionally, a large bank complex sees no signs of a late stage bull market and sees the market expanding for at least the next three to four years.

My Advice

Investing is an individual art form. The correct long-term strategy consists primarily of setting your own long-term goals and finding different ways to accomplish them. The multiplicity of the roads you travel to meet your goals must hedge the almost guaranteed probability of being wrong or uncomfortable from time to time. For most of the rest of the current year, unless the market gives us a rare opportunity to buy some real bargains or prune existing holdings, is to relax and do nothing. Those who have true long-term investment objectives beyond the next bear market can dollar-cost average into sound businesses, allowing you to relax at night.

Question:

Are you helping your children and grandchildren understand what you are thinking during these unsettled times? It doesn’t matter if you are right or not. What is important is opening up communication about how you think and how you transition when wrong, as we all will be from time to time.

 

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

https://mikelipper.blogspot.com/2020/09/headlines-excite-dictate-or-respond-not.html

https://mikelipper.blogspot.com/2020/09/mike-lippers-monday-morning-musings-who.html

https://mikelipper.blogspot.com/2020/09/turning-point-or-bump-weekly-blog-645.html

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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

T.W.T.W. > Recognizing Capitulation+Risk Growth - Weekly Blog # 559

Mike Lipper’s Monday Morning Musings

T.W.T.W. > Recognizing Capitulation+Risk Growth 

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

                                                                                                                       

The Week

A long time ago on TV, on both sides of the Atlantic, there was a comic review of the current news titled “The Week That Was” or TWTW. Occasionally, news and commentary of significance are bunched into one week, as happened this past week. The items they covered may be of serious significance for 2019 and beyond.

One Day, One Week, One Month, One Year

Some of the US stock market followers can point to instances where the first day of the year market performance predicts the first week, which predicts January’s results, and in-turn forecasts the calendar year. They have some statistics to support their view. At any rate, both the first trading day of the year and the first full week of the year produced gains for the leading stock market averages. After surviving a year where only cash produced a positive rate of return of the main asset classes, one can hope that 2019’s results will have a plus sign ahead of it. With that thought in mind, the following mutual fund performance table could address the question of magnitude for 2019’s results:

  

     Mutual Fund Major Asset Class Average Performance

                      ---------------Return----------------

Fund Asset Classes    Week Ended 1/10/19  5-Year Annualized

US Diversified Equity        +6.63%             +5.80%

Sector Equity                +5.62%             +3.00%

World Equity                 +5.64%             +2.47%

All Equity                   +4.54%             +4.47%

Mixed Assets                 +3.47%             +3.65%

Domestic Long-Term Fixed Inc +0.53%             +2.11%

World Income                 +1.02%             +1.46%

Remember, the numbers above are not our predictions, they are a look at history. There were much better results over the past ten years because during this period we saw multiple expansion. The only way for the numbers above to be achieved is for further expansion of the market multiple, assuming the optimistic projections coming out of Washington. With the current size of sales forces contracting it will be difficult unless societies (governments and Private Sector) meaningfully address the growing retirement capital deficit, even assuming the optimistic projections coming out of Washington.

I recognize that absolutely none of the readers of this blog are average investors or investment managers, but there is still hope for you and your accounts to do much better. Barrons each week publishes a list of the 25 leading mutual fund performers for the week, sourcing my old firm now housed in REFINITIV. For the week, these 25 funds had gains of 19.45%-12.43%. (In eleven instances the funds had stablemates on the list.)

Attitude Changes Required?

In analyzing the 2018 results, several deeply held attitudes probably contributed to the poor results:

• Only Earnings Per Share growth counts in selection
• TINA=There Is No Alternative to equities for success.
• Demographics is destiny (without population growth no expansion is possible)
• Four interest rates hikes in 2019.
• A bear market is defined as more than 20% from peak. (Bear Markets are a sustained period of selling by Public investors.) AAII bearish sample 29% from 50% in 3 weeks. Never higher than 50%
• Capitulation requires large selling volume followed by large buying.

Three Longer-Term Considerations

1. Ken Rogoff is quoted as saying “Over the course of this year and next, the biggest economic risks will emerge in those areas where investors think recent patterns are unlikely to change.” His lists includes:

• A Growth Recession in China
• Rising Interest Rates
• Populism undermining central banks
• Higher interest rates on “safe” government bonds 

My concern is a data dependent world where the numbers are incomplete and wrong due to disruptive technology, increased under-reported transactions, poor data gathering, data expenses that are too low, “sound bite” analysis, and surprises.

2. The Historically Speaking Column in the Weekend WSJ briefly reviewed several financial panics going back to ancient Rome and government reactions to them. The column concludes “the only thing more frightening than a financial crisis can be its aftermath”. In many cases the crisis was created by leadership trying to extend a tiring expansion beyond its “normal life.” The solutions applied were an unwise attempt to prevent a repeat of the problem without recognizing the series of faulty decisions made by leadership. This included punishment of unpopular sectors and people rather than an attempt to guide better judgement and the rebuilding of appropriate reserve elements, which could have been quickly and expertly mobilized.

3. Gallop regularly measures the public’s view of the honesty and ethical standards of various occupations. Of the 20 occupations reviewed by far the highest esteem goes to Nurses. The following table shows the ranking of the professions we deal with as part of our professional lives:

Profession      %Low/Very Low   Rank out of 20

Accountants           7%               6

Journalists          34%               9

Bankers              21%              11

Lawyers              28%              14

Business Executives  32%              15

Stockbrokers         32%              16

Telemarketers        56%              18

Car salespeople      44%              19

Members of Congress  58%              20

Similar surveys are probably done in most countries. These public attitudes are probably similar worldwide and represent a major constraining force in the development of a modern financial community where we ask people to trust both our integrity and our wisdom. My fear is that during some future economic crisis the unpopularity of government will lead to an upheaval that promises more honesty and efficiency, but in the end doesn’t deliver on those promises. As bad as our current delivery system is, it will produce better results than any other long-term system. What we need to do is make it much better.

Thoughts? 

Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2019/01/tis-season-to-be-mislead-weekly-blog-558.html

https://mikelipper.blogspot.com/2018/12/2018-lessons-should-be-learned-weekly.html

https://mikelipper.blogspot.com/2018/12/cash-is-four-letter-word-weekly-blog-556.html

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Copyright © 2008 - 2018

A. Michael Lipper, CFA

All rights reserved

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Difficult Symbols, Equity Opportunities and Bond Worries

Introduction

One of the college textbooks that I vaguely remember made a big thing of people being either inner or outer directed. In truth, I suspect that each of us are in different ratios at different times and conditions. Over the last six to eight weeks there have been many trumpet calls trying to lead us into new and/or strong beliefs in answering our needs for outer-direction. Being a skeptic by nature I am recoiling from these attempts to lead me and others.

Different Inputs for Trading and Investing

As we can not avoid being influenced by some outside influences, I try to be selective. I regularly quote  Jason Zweig, one of the better students of investment behavior. In his latest column in the weekend edition of The Wall Street Journal, he cautions about the influence of others on investment decisions. He acknowledges that many want the comfort of going along with the popular mood of the time. One of the ways I control my investment urges is to identify what it is I am trying to accomplish. If near-term success is important, other's opinions that support the current momentum can become dominant. If I am focusing on building a long-term oriented portfolio of securities and funds, I am much more likely to search for counter trends.

You can do a little bit of both if you segregate your money and your actions. In our four sub-portfolio approach, TIMESPAN L Portfolios^®, we are very conscious of both momentum and counter trend investing. The Operational Portfolio to pay bills in the next one or two years needs to be cautiously sensitive to momentum. The Replacement Portfolio is very much oriented in replacing the capital that has been used to pay current bills along with the almost certainty of some market reversals. The Endowment Portfolio is designed to generate capital for those that are currently alive. This portfolio accepts periodic down markets, but essentially is focused on investing wisely for the long-term. The Legacy Portfolio needs to recognize much of what is expected won't happen as intended. Thus the Legacy Portfolio will include investments that are part of the disruptions that regularly occur. In this way one can use your outer directed and inner directed instincts.

Symbols

Political and religious leaders going back to Biblical times used concrete symbols to convey the abstract, unseen  power. Remember the Golden Calf, the grandeur of Rome, staged events in Nazi Germany. To some extent various inaugurals and marches serve the same purpose, that of a symbolic message to convey outer-direction to the masses. As with most symbolic promises, the deliveries will be different. This is particularly true today when new interpretations will change the more current views of symbols. Bottom line: enjoy the massive pageantry, but expect severe modification.

Upsides for Stocks Possible

Though we have had a long, but mild expansion, is there room for more economic expansion in the US and elsewhere before historic limits lead to a bear market for stocks? Without predicting it, a look at the data says it is possible. According to government sources we are currently operating at about 75% of industrial capacity when other booms topped out at close to 83%. Also only 57% of working age population is actively working when recently close to 60% were working.  However, if one looks deeper, there are a number of doubts. Most importantly we are no longer a heavily weighted goods producer dependent on domestic industrial capacity to turn out these goods. Further, I suspect that we are actually using a significantly higher percentage of modern capacity. Where there is scope for substantial expansion is in vastly improving our transportation capacity of airports, roads, rails, harbors, etc. These will require long lead time efforts and probably will depend directly or indirectly on private financing.

Actually one of the retarding factors to increased production is finding qualified, honest, high energy workers with appropriate skills. Thus there is a need for a massive infrastructure investment into schooling at all levels with the hope that it will lead to useful human education. This is a huge necessity throughout the developed world. We need smart, reliable workers' earnings to pay for our expanding healthcare costs as well as the need for protection domestically and internationally. The US could be a leader on this front, but we will have to move fast.

Much of the future will need to serve two new unaccounted for masters. The first are the growing number and money of the consumers. While management and labor are often represented in some of the halls of power, the consumer is not. We need to respect and serve the consumers. The second growing power who is critically involved with effectively serving the consumer is the corporate state. While their first loyalty will be to their customer bases, they will also serve their multinational owners and lenders. The consumers will increasingly buy what they feel is good for them and not where it is produced. The consumers and the owners will focus on what is good for them and use governments to help or at least not hinder them.

At the moment the symbols for this new world are not apparent to me.

Stocks’  Biggest Worry is Bonds

If you are a regular consumer of the financial media, you would believe that stocks are bigger and more important than fixed income securities. Any careful reading of financial history will disabuse of this thought. Most financial crashes occur because a fixed income relationship is or has failed. For example most of the blame for the collapse that centered around 2008 was due to improper mortgages and their derivatives. The strain coming out of the collapse put banks and leveraged brokerage firms under extreme pressure. Congress, various Administrations and most mutual fund shops escaped blame, despite having some culpability. This was just latest chapter of runs on banks in many countries due to imprudent bank loans.

Because of this history, as primarily an investor in equity funds and individual stocks I keep an eye on any indicators of potential trouble in the fixed income world. Often the litmus paper test of some problems is that yields rise as inducements to accept some troubled paper. As previously written about in past posts coming out of the US election, there was a desire by some institutional investors to "re-risk" their portfolios. In the last week we saw two examples of this. The yields needed to move a number of European Sovereigns rose. Second, each week I look at what Barron's calls yields on best bonds, which I assume means of highest quality. In the last weeks their yields rose to 3.50% from 3.41% the week before. (Remember bond prices go down when yields go up.) The nine basis point gain compares with only three basis point increase yield for intermediate quality paper. I have not included yields on high yield bonds who are bought by those who can tolerate risk in some cases similar to stock risk.

Summary

We  are becoming more cautious, but not yet bearish. We will need to pick our spots and time the purchase of stock funds with any excess cash.

Question of the week: What would cause you to change your current investment policy?      

__________

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

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com  

Copyright © 2008 - 2017

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Investment Survival in a Disruptive Age

Introduction

The First Commandment for all investors is to play to survive.

In my discussion of the Legacy Portfolio part of the Timespan L Portfolios^®, I suggest including stocks and funds that focus on being disruptive to the established order. Thinking deeper about the attributes of disruption, I know we have entered a disruptive age.

If you are a keen observer you will see that almost every major activity is experiencing some form of disruption. In virtually all areas we are trained in some classical way of thinking derived from past successes and failures. The neuroeconomists at Caltech assure me that we make important judgments on the basis of our or others’ experiences. We like to follow patterns. The problem with this comfortable approach is that in many spheres there is disruption. Just look at Science (colliding black holes creating time warp evidence), Economics (experimental quantitative easing), Politics (populism usurping establishment roles), and even some money managers. Our instinctive reaction is at first to reject the disrupters and then fight them as they are threatening our classical way of thinking and operating. What we should be doing is examining the facts/data and trying to understand the power of their proponents. Whether the disrupters are right or not they may represent an opportunity. They may not be completely wrong, and without rigorous study we may not recognize when they are more right than our older models.

This is far too big of a series of subjects for me to thoroughly deal with now. Because I feel that I have some responsibility to those that have used various investment performance measures to select mutual funds and other managers based on their past records (which for a period of about a year have been underperforming) this set of disruptions deserves some attention. I am going to briefly review what is in the process of changing which may explain what is now happening and more importantly what may happen.

Sound Bites

Look at almost any front page of a newspaper or the first story on a so-called news broadcast. The strong odds are that it will be negative in terms of life, limb, and the pursuit of happiness or gain. We need to understand that the media has discovered that negative sells. The people who believe that principle the most are the politicians. In almost every country they are focusing on the problems as a way to attack the “they” who need to be replaced by a different set of politicians. Interesting that each day many if not most things in this world get a little bit better.

Last week I devoted most of my blog post to the annual letter from Warren Buffett as edited by Carol Loomis. I, and others, found the letter to contain reasons to be bullish in the long-run. In her letter this week to her largely retail audience, Liz Ann Sonders stressed a preference for what Mr. Buffett was saying rather than the politicians and their pleas of misfortunes if they are not elected. The statistical odds favor investing in US equities in the long-run.

The Cost of Regulation

Around the world banks and other members of the financial community were blamed almost exclusively for past financial crises. To prevent repeats without reforming the political leadership, the financial community and particularly the large banks were subjected to intense and costly regulation. Due to this additional regulation banks need to increase their capital at all levels. The higher the value placed by the market, the belief is the better the future results and the lower the cost of raising the required capital.

According to Standard & Poor’s the price/earnings ratio of the banks in its 500 index is 12.38 X where the P/E for the banks in S&P's small cap 600 Index is 18.51 X. Thus the smaller banks have to give up less of their equity to get capital than the larger ones. In a period of manipulated low interest rates banks will have difficulty making enough money to attract more capital to make more loans. One of the disruptive forces being unleashed are non-bank financials that are less regulated and often less transparent. Thus the portions of the economy that need loans will likely get their loans with less regulations but at higher interest rates. In Europe banks are often less well capitalized and in some cases have materially larger non-performing loans relative to their assets.

Most private businesses get their money from local banks. In the US, businesses approaching mid size have the option of publicly issued paper. This would be a new experience for many European companies which they may find disruptive in terms of disclosures, costs, and tax implications. On the other side of the coin, retired individual pensioners are not earning enough on their deposits to meet their living needs. So their senior lives have been disrupted.

Price of Oil Links

Disruption can be positive or negative in terms of direction and whether one is a natural buyer or seller. The more established participants are in the camps of lower prices for longer. Moody’s has just lowered the credit rating of many Gulf and African government bonds. T Rowe Price New Era Fund which maintains half of it portfolio in energy stocks views that the price can descend into the twenties from the current prices in the thirty dollar a barrel range, rebounding for a longer term target of $40-50. Sounds bearish, but in February the leading developed market broad market index performer was Canada +4.27% compared with S&P’s measure for the US of ‑0.28%. (For many years, I have hedged my investments in US domiciled mutual fund management company stocks with some of their cousins above the border.)

Another link to the disruptive changes in oil prices are many securities in the emerging and frontier markets. In general, as a group they have fallen in sympathy with the fall in imports into China. One of the reasons for the decline in energy prices is a cutback in its imports of oil and other raw materials. Based on their valuations close to the lows of the prior cycle, they appear to be “cheap.” They may be cheap, but not a bargain. In revamping the Chinese economy its import needs may be permanently altered which would certainly be disruptive to buyers of these stocks.

How to Invest In a Disruptive Period

During disruption, most of us mere mortals do not know how things will turnout. We do know that we are in a period of rapid change at many levels. While we may return to the pre-disruption stage, it won’t be really the same because in the back of our mind we know that there has been a disruption and others could come.

The standard investment strategy in dealing with risk is to diversify into different instruments. Most investors do that within various individual securities. What we do for clients is to offer a better way to diversify. We assemble a specific portfolio mostly of mutual funds from different managers who think differently about market conditions, risks and opportunities. All too often even those who are early recognizing a problem or opportunity only see a portion. Hopefully we can assemble a task team that can get a fuller picture and thus give us and our clients more confidence in dealing with disruptions.

I would be happy to discuss how to deal with the disruptions that you perceive.

Question of the Week: When was the last time before an important election you were correct as to what the newly elected leader was able to deliver?

________   

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Comment or email me a question to MikeLipper@Gmail.com.

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Copyright © 2008 - 2016

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.