Introduction
The great and
late Yogi Berra, said "You can observe a lot by just by watching." I
will attempt to see the future by observing the results of the recently
concluded third quarter of 2015. My attempt will be as a “fox” forecaster
rather than a “hedgehog,” as described in a new book, The Art & Science of
Prediction by Philip Tetlock and Dan Gardner. They divide predictors into two
animal groups the hedgehogs who focus only on a very few variables in order to
hedge future results and the foxes who recognize that the future is too complex
for simple forecasts. I am with the second group.
Hedgehog
Capsules
The third
quarter saw almost every asset class decline in price except US
Treasuries. The
two largest economies in the world showed signs of slowdowns, albeit China from
a much higher growth rate than the US. The manipulations of the leading central
banks continued. Those that were data dependent extrapolators did some selling
and less buying for their long-term obligations.
Foxes Look for
Changes
As dependable as
the laws of gravity, I look at various declines as setting up a change in
direction. As a young analyst I got frustrated at market bottoms because they
very rarely got to be real cheap or almost steal price levels for long. What I
neglected to put into my mathematical projections is that other potential
buyers were also waiting for a good entry or re-entry price. These buyers were
less patient than I was because they had fiduciary responsibilities and had a
lot more money that needed to be deployed. They bought the cheap stock at good
prices and didn't wait for my bargain basement prices. This experience taught
me to begin buying when prices get into the fair level in view of their long-term
future value. This is not to say that I am unworried about a major rip in
the market structure that could delay the turnaround for a long time, and there
is a potential one today that will be identified later.
How Should
Analysts Work?
All too often
what passes for analysis is a description, often detailed, of what already
exists. Analysts should focus their attention on the future risks and
opportunities. In other words, they should recognize that they are part of the
tribe of foxes as predictors. To be successful more attention should be paid to
the forks in the road as turning points and far less on trends and the determination of central values.
My Analytical
Applications
I start with the
absolute certainty that no narrowly defined trend will continue in its present
configuration. Thus, I look at extreme performances as the most likely trend
reversals at some point along their route. Guessing that there are strong odds
on a trend reversal is relatively easy. The timing of the turning points is
more difficult. It may be sufficient to recognize early that a turn has already
happened or is in process. One of the great advantages of being a chart reader
is the emotional ability to accept the turn without fully understanding the
causes for the turn. Often the people and the conditions that cause the change
in direction will be learned later, long after the easy early money has been
made.
Currently I am
focusing on the worst performing sectors of various markets. I recognize that
not all of the poor performers will turn to be good performers and not at the same
time. Some of the bad performance is due to poorly executed or too expensive
strategies. Nevertheless, when there is massive under-performance by activities
that were formerly viewed to be well managed, the instincts of the fox in me
want to explore further. After assuring myself that what I am seeing is
cyclical behavior, as a good US Marine Corps officer I start to prepare my plan
of attack.
First I am
focusing on investments that have declined around 20% compared with
general declines of 5 to 10% through the end of the third quarter.
In a gross over-simplification most of these formerly very successful
investments have for many years reacted to falling commodity
prices. In most cases (in an age old pattern of increasing supply too far
in advance of demand) the clearing of the demand level was
achieved by lower prices. Quite possibly prices would
have eventually
declined without the slowdown of growth in China and the
widespread application of lower cost extraction techniques for oil and particularly gas. Combining these factors with the two largest economies
becoming less manufacturing and more services-oriented, the general price levels’
secular rise fell off their trend line to reported slower augmentation.
Having been
exposed to past industrial cycles, I expect the excess supply will be
eventually absorbed or removed from near-term production.
Further, while population growth is slowing in many countries, the
existing populations are increasingly exposed to more expensive
lifestyles. Thus, I expect we will see reported inflation rise. As a matter of
fact, I believe the cost of living for the readers of this blog and many of
those who they are responsible for are already
experiencing
upward effective price changes, above the vaunted 2% level.
How Do My
Portfolios Represent These Concepts?
I have a number
of portfolios for different purposes and timespans. (At your leisure
I would be pleased to discuss the application of the Timespan L
PortfoliosTM to your specific needs.) Most of my timespan
oriented investments are long-term and some very long-term. The
guiding principles of my choices are to avoid substantial long-term losses
with major positions and at the same time produce a more than
acceptable return. This translates into some Canadian and Australian investments.
I wish to stay within my circle of
competence as is
often suggested by Charlie Munger and Warren Buffett. Thus, I invest in each of
these commodity based currencies in mutual fund management companies and
closed-end funds. I also have a position in the largest commodity fund management
and selling organization. Further, in believing in the continuing treachery of
central banks to savers, we have a significant portion invested in global fund
management organizations as they are avenues for people all over the world to
partially escape the debasement of their currencies. For those that must have
some of their money in fixed income, we have used TIPS (Treasury Inflation
Protected Securities) and for clients who can accept some volatility, income
loan participation funds.
Changes in the
law may improve the quality of these loans if the banks must keep a
small portion of the loans on their balance sheet.
What Should You
Do?
My
recommendation would be to begin a buy program of investing in the prospect of a
long-term increase in inflation either through a commodity, direct or related
investments, and in the worst performing US government issues of the last year,
TIPS. I would slowly average into these positions by adding to them 1% a month
or a quarter. When they move up in price by at least 9%, you may want to
consider taking a full normal position.
However, There
is a Big Disruption Risk
When there is a
large scale disruption in the marketplace all securities and investment
plans are impacted, as a rapidly falling level of trading capital needs to
be quickly redistributed from strong holdings to meet pressing
repayment demands.
The history of
monetary demand management by the Federal Reserve is that market
bubbles are reduced by opening new arenas for speculation. When we were
facing the collapse of wide-scale speculations in "Dot-Coms" the
Fed and the Federal Government made highly leveraged, poor credit quality
attractive to new home owners and institutional investors. The
result was the "sub-prime" collapse. As this was getting
painfully unwound a new and bigger bubble was created in using US
Treasuries on leverage for collateral purposes in “carry trades.” Because the
credit quality of the Treasuries were unquestioned by
all except Standard & Poor's, one could borrow heavily against
them. The borrowed capital was then used to buy higher rate
paper, often emerging market debt. These countries were borrowing
US dollars at lower interest rates than what was available in
their more knowledgeable local markets. Many of these borrowers were
reliant on commodity prices remaining firm which currently is not
the case.
At the very same
time with the advance of high computational and communication
speed, high frequency traders were attracted to the market. These
inter-market dealers with their use of algorithms already
represent, I am told, over half of the trades in the market. Many believe
that they are abusing the market dynamic in Treasuries as
they have in other markets. A number of sound, well known hedge
funds have complained about these activities in terms of stock prices
not representing real demand levels. My guess is that
something will
be done about these specific abuses. My further guess is that
the regulatory authorities will be reluctant to further constrict the Treasury
market when the US government has to continually
borrow money. Eventually the regulators will be forced to curtail these
activities, but that is only likely to happen after a major disruption.
With Possible
Disruption Ahead
Invest
cautiously. When and if the disruption does occur, treat it as a periodic
change in market structure unrelated to the underlying economy and as a buying
opportunity.
Question
of the Week: Are you preparing to change your style of investing?
_________
Did
you miss my blog last week? Click here to read.
Comment
or email me a question to MikeLipper@Gmail.com .
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 - 2015
A.
Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.
Posts
