Being Long is Worth the Bet - Despite Consensus

Introduction

Consensus turns out to be correct occasionally. As  alluded to in last week's post, published bookmakers’ odds are simply the ratio of the amount of money bet on a particular horse, issue, or perhaps someone running for election. There is often a big difference in the confidence expressed by aggregate money and the probabilities of success. Even to themselves (let alone to any third party) voters rarely say why they voted the way they did. After many political elections the people who claim that they voted for the eventual winner is significantly higher than the recorded reality. It is not my professional function to guess which way an election will turn out and history suggests it may not matter as events that take place after the election will determine the enacted policies.

As a professional investor and portfolio manager for institutional and high net worth clients, the essence of my job is to make reasonable judgments about the future course of markets; first to reduce the chances of meaningful capital losses and second to increase the opportunities to grow capital. Notice I phrase my tasks in terms of chances. In other words, I focus on the odds. Thus, one can see why I believe my early exposure to going to the racetracks was instructive. At the time the New York tracks offered the most in prize money and therefore probably had not only the best horses running but also the savviest bettors.  (This was good training for future competition in picking stocks and funds.) At the track the amount of money bet on a particular horse identified the favorite of the betting crowd's dollars. In other words the favorite was the consensus bet. There were two problems with betting on the favorite. Roughly they win only about a third of the time. More importantly the winning payoff from favorites rarely covers more than one losing bet and often not enough to bring the losing bettor to break even. As we all are driven by our own experiences and hopefully those of accepted others, I do not favor consensus bets for investments.

Reading the Consensus is Useful

One of the important investment lessons is that to be successful is to be dependent on someone else to buy your merchandise at a high price. Thus, it is critical to understand the motivation of other investors. By definition many investors are guided by the consensus. 


If one reads what most of the pundits are saying they are more concerned about the present risks than opportunities. This is understandable in view of slow growing or contracting economies with declining productivity, political uncertainties globally, and low nominal manipulated interest rates. A number of market analysts are flashing danger or at least caution signs and reminding us as to the current length of the bull markets.

Consumers are worried about their own economic future. With the mix of population growing older some people may be worried that their retirement capital is insufficient. (Long-term this could be a positive for the investment segment of the market.)

Missing Opportunities from the Past

Going back to the horse racing analysis, longer races allow for temporary recoveries and tend to favor higher quality horses. The same is generally true with investments. In his recent blog,  Bill Smead of Smead Capital published the following chart:

                                 

S&P 500: 1926- 2015

Time Frame	% Positive	% Negative
Daily	54	46
Quarterly	68	32
1 Year	74	26
5 Years	86	14
10 Years	94	6
20 Years	100	0

Two worthwhile items to note. The first is that the table is just expressed in gains and losses and their size. The second is that historical experience supports our concept of the TIMESPAN L Portfolios ^® . We assume that the shorter term portfolios will produce more cyclical performance and the longer term portfolios will show more secular growth.

One attempt size the positives and negatives is this week's Barron's Big Money Poll. Among other questions, one asked what were the chances that the S&P500 would reproduce its long-term performance of approximately 9% per year?  Of the responses, 80% felt that it would not produce this return over the next five years, but 44% of the participants felt that over ten years the index would also underperform. The implication is that the aggregate group is looking for an acceleration in growth in the second five year period.

My Guess

With so many people being worried about the outlook, particularly the near term, I believe there is not a great deal of risk in terms of the permanent loss of capital by remaining long this equity market. I am somewhat comfortable accepting that there can be intermediate price declines of up to 25%. Over the next five to twenty year periods mentioned, there are upside potentials of multiple doubles. Thus it is worth the bet.

Caution

For those that attempt to use any particular day to trade rather than a long series, be careful about intraday trading. Currently on many days the pattern of trading is similar to those that my grandfather knew. This view is reinforced when one looks at the number of floor traders working orders at trading posts on the floor of the New York Stock Exchange as shown on cable television. They are busy on the opening and closing. For periods in between, I suspect they are active in off-floor trading with institutions. The opening benefits from orders from Europe which often means more buying than selling as long as the US dollar is rising in value. (I do not expect that the trend to continue.) I have noticed that unless the market is strong at the end of the day, often the gains of the session are reduced as traders want to lessen their exposure overnight.  Investors should be conscious as to the timing and methods of placing orders as it is an important skill in this period of low returns. One of the advantages of using mutual funds as the medium of investment is that orders for fund shares are executed on a forward basis meaning that execution price will be the price of the net asset value on the close.

In Conclusion

Use consensus not as a guide but as a recipient of your investments. Relax through periodic declines. The odds favor the long-term investors.

Copyright © 2008 - 2016

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

Are you an Investment Trend Follower or a Selector?

Introduction

Are you an investment trend follower or a selector? The answer to the question will determine the result and the comfort level of your volatility.

Many institutional and individual high net worth investors inherently believe in the comfort of being gathered into the current central tendency of the market. They fundamentally believe in the phrase “the trend is your friend.” Others with some exposure to the sports and/or political world are very aware that there is an end to every trend which can be surprising and dramatic. Other investors practice a diversion from the central tendency by being selective.

The “H” and “T” Choices

While each of us think we can easily make rational choices between trend following and selectivity, to go against the trend you may have to identify whether you are more “H” or “T.”  Briefly “H” stands for Herodotus and the “T” for Thucydides. Both were historians  of ancient Greece. The first has been called “The Father of History” and by some “The Father of Lies.” He was among the first to write down the combination of what he saw and what we would call oral history without much authentication. He put these stories into a continuum in order to show a developing trend.

Thucydides  has been called the father of scientific history. Unlike his predecessor he did not often express an opinion and required hard evidence in the experiences beyond his own. In effect, he was a collector of incidents including the motivation and expertise of the main players. I must admit to a leaning in his direction as he was a general in addition to be being a historian. His history is required reading in the US Naval War College.

Why are so Many People Wired to be Trend Followers?

Which way we have been taught may very well have to do with a political decision made by the Communist Party in the US and probably elsewhere in the 1920s. The party saw that it needed to convince people as to the inevitability that communism would triumph eventually. They were clever in getting educators at various universities, high schools and even grammar schools to accept these so-called trends as the way the world will go, thus building the belief in the inevitable march through the left to socialism and then communism after a number of generations. Many, if not most of us have been schooled in trend identification and following. Once this becomes our main thought process toward political history it is difficult not to apply it to our investing.

Trends Don’t Last

A careful study of the history of almost any topic will show that the human genius often comes up with intelligent breaks of emplaced trends, be it fashion, art, music, politics, sports or investing. While there are some risks in being too early in deviating from the existing trends, the loss of capital opportunity of getting on sound future trends is much more expensive than being too early.

The Job of a Professional Analyst

The most important job of professional analysts is to act as Thucydides would to examine what is actually happening and apply the lessons prudently. This is what I attempt to do every day for the benefit of my accounts. I do this with the comfort of knowing that most investors will be trend following. This will help in keeping my losses relatively small when I am too premature and have the pleasure of selling into the crowd when the new trend becomes acceptable.   

This Week’s Historical Implications for Possible Trend Disrupters

Last week the Chief Investment Officer of Matthews Asia with his forty strong investment group had a breakfast meeting at a midtown Manhattan hotel. He is betting on rising wages within Asia led by China and India to create massive consumer spending. (Interesting that the government of China recognizes that its hold on power is dependent upon job creation funding a rising standard of living.) He expects that China’s former role as the driver of demand for many industrial commodities will be filled by India with announced major infrastructure projects. To accomplish these goals India will need (as in China) to pay attention to the level and grasp of corruption. Asian stocks while not relatively cheap in terms of price/earnings ratios, appear to be relatively cheap on a price/sales ratio. I would be focusing on the spread between return on invested capital and return on equity to focus on the risks of over-leverage. As these countries move from low wages to higher, I find operating earnings per person is a trend of particular interest to me.  

Much of my focus on deeper financial ratios comes from almost a year solely devoted to getting my arms around General Electric in the mid 1960s. Interesting from my seat at the breakfast last week I could see across Lexington Avenue to the entrance of what used to be the General Electric headquarters building. One of the reasons I question lots of trends is that while the numbers proceed, the way they have been generated has changed to such a degree that past comparisons are less meaningful. My analysis of GE was that the company was essentially a manufacturer which had various financial and insurance activities to support the manufacture and sale of its products.  That started to change as the CEOs changed. GE moved its headquarters to lower-taxed Connecticut and started to grow GE Capital into an independent, financially aggressive series of unrelated activities. The move to southern Connecticut cut the taxes for the most senior executives living in that state, and detached itself from the New York financial community. Initially this helped GE overcome an aging plant and employment base, but it also fundamentally changed the corporation into a materially slower operating growth company on the industrial side and increasingly dependent on, in my opinion, lower quality earnings from GE Capital. Thus while GE is probably the only stock in the Dow Jones Industrial Average stock for the last 100 years, its long-term trend is not particularly useful in predicting its future stock price.

Brokers are Sharing the Disappointment

The pre-Tax Return on Equity in 2014 was 9.2% compared with 25.1 % in 2000 and 40.3% in 2009 for the aggregated NYSE reporting firms according to SIFMA, the industry trade association. Revenues are less than half their peak levels of 2007 and have been essentially flat at $165 Billion between 2008 and 2014. The number of registered representatives for FINRA has not varied much since 2009 and is now 637,000.  The average annual turnover rate of shares traded on the NYSE is the lowest it has been in the last 15 years.

What has gone up and shows the change in the structure of the market is total margin credit (borrowing); in 2014 it reached $456 Billion compared to $187 Billion in 2008. The growth in margin credits is a mirror of the growth in hedge funds and other trading vehicles. Another growth element through 2014 and probably reversed (at least temporarily) is the portion of the Global Equity Market Capitalization that is now 23% which is double its 1995 level of 11%. When Emerging Markets return to favor there is a good chance that the 42% invested in the US will drop. (Any investor that has more than 50% invested in the US is betting against the rising standard of living outside of the US.) This is a major change in the structure for the long-term demand for US stocks.  For those who have a portfolio structure similar to our TIMESPAN L PORTFOLIOS^®, I would recommend to have significantly greater international holdings in their Endowment and Legacy Portfolios than their Operating and Replenishment Portfolios. Charles Schwab’s next 12 months earnings growth is 2% higher for the Eurozone at 15%, and 5% higher for Emerging Markets.

Bulls Could be Disappointed

Readers of my blog know that I don’t like being in crowded trades, viewing that often one’s co-venturers in a security are potentially a greater source of price risk than the issuer itself. Further, I have often identified that I manage a private Financial Services fund. In this week’s Barron’s nine investment strategists were asked to pick their favored sectors. Eight had financials in their selections. The saving grace for me is that I believe our stock selection is quite different than the bulk of others, without significant holdings in commercial banks, credit card networks or life insurance companies. Nevertheless, I get concerned when new money is coming into my neighborhood.

All is Not Clear Sailing Ahead

The Third Avenue Focused Credit Fund has had too many redemptions so has suspended the ability to redeem from the fund. This is particularly instructive on a number of levels. For some time the yield spread between high yield paper and US Treasuries has widened considerably. At the same time the credit rating agencies have raised their year ahead estimate of the percentage of high yield paper that is likely to default. The combination of low sales growth, falling energy prices, rising interest rates and maturing debt schedules are some of the market’s apprehensions.

What is fascinating to me is that the management company was founded by Marty Whitman, a 91 year old  very successful distressed securities player who made a lot of money for me. As part of my research on closed end funds that we were tracking I bought some shares in a West Coast fund that was being managed by a trust bank, but was selling at a big discount. Mr. Whitman bought control of the fund and converted its portfolio into a distressed securities portfolio with particular focus on firms that had large tax loss  carry forwards. He then merged operating companies into those with large losses and thus freed them of a tax burden. This was a wonderful investment particularly as it was not an open end fund that had to meet redemptions. To me this is the appropriate place for investing in similar merchandise, not like the Third Avenue open-end fund.

Fund pioneer and value investor Max Heine with his associate Mike Price at Mutual Shares did the same thing on a smaller scale in their open end funds which always carried large cash reserves plus a portfolio of very liquid stocks. There is nothing wrong with selectively owning distressed securities if you know what you are doing and do not need liquidity in a market with shrinking risk-oriented liquidity. (If anyone is interested I will share what I did with cumulative shares in arrears as a another distressed securities play.)

The final possible storm warning is the interest rates that many banks are offering for deposits. Just this week the average dropped to 0.26 basis points from 0.28 the week before and 0.44% earlier in the year. There is a demand for loans, but banks may be so constrained by bank capital requirements they would prefer to keep their money with the Fed or in the highest quality corporate bonds whose yields according to Barron’s are averaging, 3.74% which is more popular this week than last.

Question of the Week: What portion of your portfolio do you consider significantly different than mainstream thinking?

_________   

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.

Inducing a Recession, Opportunities?

Reading the general and financial media, be it print or on a screen, most of us see disappointment. In part because of our disappointments with political leaders around the world, we are taking away their firepower by inducing a recession. We are disappointed with the various politicians for their reluctance to solve the growing gulf between what we want to receive as a society, and what we are willing to pay for in the way of taxes and fees. Since political leaders wish to get elected, they are reluctant to force the narrowing of this gap.

As political leaders like spending as much as getting elected, we are pressing them to cut expenses, mostly by cutting the other person’s entitlements or benefits. This less spending without an offsetting increase in the private sector will shrink the size of the global economy. Since the expected general level of demand will be reduced thus creating a recession, many are already cutting back on expenditures and have a pessimistic attitude toward investment obligations to themselves and others.

Two extreme behaviors

The first extreme behavior assumes the worst is compounded into tragic levels. Since politicians won’t lead, in this scenario we will see the equivalent of the “Man on Horseback” taking charge and forcing a solution, usually by attacking one or more groups. The dastardly actions of various dictators of the 1930s who “solved” the crushing debts of their country are the source of some people’s paranoia. Following historical precedents, the group to be attacked are the wealthy people, who fear a pillaging of their assets. This fear is palpable today for some. In an investment group meeting last week, we were informed by a third generation dealer in gold bars and coins that sales of these items for personal delivery are skyrocketing. The announced intended purpose for this portable wealth is to pay bribes to cross a border. For some, this was experienced during their lives or their parents' lives in Europe and Asia. Others feel that their wealth is threatened by various left leaning governments, including the present gang in Washington. Their demand for physicals is such that new vaults specifically designed to hold gold, and to some degree silver, are being sold in London and elsewhere. Perhaps another example of this conversion of fiat currencies is that the highest priced real estate properties are selling very well.

The second extreme behavior is that some are buying in the face of plunging stock prices around the world. The buyers could well be traders who recognize, using the past metrics, that both the S&P 500 and the MSCI EAFE are oversold by a significant amount, at least as of Thursday’s close. The other possibility is that the buyers are really investors who know something. My brother points out that our grandfather, based on decades of Wall Street experience, told us that the person on the other side of a trade may know as much, if not more, than we do.

Asian Lessons

Perhaps the rumored flirtation of the Chinese for Italian debt was aborted by their analysis that the rating agencies would lower the credit rating on both the sovereign debt and two of the largest banks in Italy, which occurred last week. A more difficult factor to consider is the announcement last week that FedEx is significantly lowering its estimate of the growth in revenues of expected parcel traffic from Asia for the rest of the year. What requires more study is whether the projected drop in growth is due to an expected dip in the sales of Christmas items in the US. Historically, we have thought of Asia primarily as exporters to the US and Europe. However, our Asian portfolio managers point out that over half of Asian exports are now done within Asia. If the expected decline in the growth of air freight shipments is due to an expected weakness in the Christmas trade, that fits with the induced recession scenario. If on the other hand, the growth of consumer demand within Asia is softening, this could be much more serious. The continued growth in Asian consumer demand is critical to my long term investment philosophy, and to others as well.

What is happening in the “Real World?”

According to a survey done by JP Morgan Chase, 75% of small company CEOs are planning to add people in the coming six months. They may feel that they have a chance to fill a void left by their larger competitors who are pulling back. What appeals to me is that there is an abundance of high quality talent available, either already separated from their employers, or people who are available for the first time.

What should Investors Do Now?

We are reducing our fixed income exposure for our long term accounts who perceive that they have extended obligations to various beneficiaries. Soon the only high quality fixed income that we intend to own will have short maturities. Periodic, planned increases in equities make sense for many of our institutional and High Net Worth clients.

What are you doing with your portfolios?
-----------------------------------------------------------------------------------------------
Did you miss Mike Lipper’s blog last week? Click here to read.

Add to the Dialogue:

I invite you to be part of this Blog community by commenting on my blog posts or by adding your perspective to the topic. All comments or inquiries will be handled confidentially.

Please address your comments to: Email Mike Lipper's Blog .

To subscribe to this Blog, or to refer a colleague or family member, use the email box or RSS feed sign-up on the left side of MikeLipper'sBlog.Blogspot.com

IS THIS BLOG USEFUL?

As I approach the 100th posting to my blog, I would like to hear from you whether this is useful to your needs, if so, how?

Please take a moment to answer these three questions:

• Is this blog useful to your needs?
  
• Was any specific blog post particularly useful?
  
• What investment advice/counsel are you NOT receiving?
  

Please take a moment and Email me



I assure you that any replies will be strictly confidential.


My goal has been to present thoughts on topics relevant to my family, to our clients, to the beneficiaries of our clients as well as to high net worth and ultra high net worth investors.

My previous 96 blog titles are listed below. Though each post is still viewable, the older pages may be difficult to navigate. If you would prefer, let me know in your reply Email, and I will send you a copy of any previous blog post(s) you would like to read.

• #96--The Declaration of Independence and Your Investments
  
  
• #95--Is Breaking Even Equal to Breaking Up?
  
  
• #94--Unpredictability and My Grandfather
  
  
• #93--Too Much Focus on Short Term Imponderables, Not Enough on Long Term Challenges and Opportunities
  
  
• #92--The Buyers’ Strike May Continue; Was Friday a Clue?
  
  
• #91--On Memorial Day, and the Future Leaders of the Investment Community
  
  
• #90--Unintended Consequences: Investors Again Lose to the Politicians
  
  
• #89--The Fork in the Road to Your Investment Policies
  
  
• #88--Why Didn’t We Buy? Did the Game Change?
  
  
• #87--Answers from Warren and Charlie - Omaha Highlights
  
  
• #86--Why Some Individual Investors Produce Better Results than Investment Committees
  
  
• #85--Too Much Reliance on FICC Can Be Dangerous
  
  
• #84--“The People” vs. the Economies and the Markets
  
  
• #83--Leadership Companies Are Not Always Leadership Stocks
  
  
• #82--Are We at a Turning Point or at a Vantage Point?
  
  
• #81--Twenty, Forty, Sixty: We are Going Global
  
  
• #80--A Rainy Weekend or a Prerequisite to a Future Bloom?
  
  
• #79--“End Game” Training for You and Your Heirs
  
  
• #78--When Warren Buffett Speaks About Investing, the Wealthy Should Listen
  
  
• #77--Connecting the Dots and Fears Are they Already in The Price?
  
  
• #76--Valentine’s Day Challenges for Ultra High Net Worth Investors
  
  
• #75--“Stop the World, I Want to Get Off,” I Don’t Want to be Global
  
  
• #74--The Price of Lack of Clarity on Your Investments
  
  
• #73--The Super Bowl and Fund Selection II
  
  
• #72--Enjoy a Laugh on My 10 Year Investment Plan
  
  
• #71--Investment Policies for Investment Personalities
  
  
• #70--The “Fifth Season” for Investors
  
  
• #69--Boxing Day and Bond Funds
  
  
• #68--More Positives than Negatives Ahead
  
  
• #67--Will it be Safer to Go Back Into the Water After the Financial Services Legislation?
  
  
• #66--W
  
  
• #65--The Good and the Bad about “Black Friday”
  
  
• #64--Changes to Risk Compensation and “Best Practices” Are They Barn Door Closers?
  
  
• #63--Post Mortem 2007-8 and Pre Mortem 201X
  
  
• #62--Winning Calls
  
  
• #61--Random Thoughts on November 1st
  
  
• #60--When Experience is not the Best Teacher
  
  
• #59--Are We Selling the US Too Short?
  
  
• #58--On Building Effective Investment Committees
  
  
• #57--Old Money vs. New Money Mistakes
  
  
• #56--Seven Steps For Giving to Charities
  
  
• #55--Wrong-Headline Risk
  
  
• #54--Who are Better Equipped to Make Decisions?
  
  
• #53--Searching for Innovations
  
  
• #52--Are We Gambling Too Much and Speculating Too Little?
  
  
• #51--Possible Implications of Statistical Traps
  
  
• #50--Setting Investment Goals Properly Through the Use of Science and Art
  
  
• #49--The Art Form of Selection for a Portfolio of Funds
  
  
• #48--I have met the enemy which has trained us.
  
  
• #47--Learn from London and Paris But Invest Creatively Elsewhere
  
  
• #46--Modified Behavior = Intervention vs. Newton
  
  
• #45--Can We be Independent?
  
  
• #44--The Temptation to Go Short
  
  
• #43--The Aging of the Uncertainty Principle
  
  
• #42--The Scots May Understand the Current Rally
  
  
• #41--Investment Lessons from the Belmont Stakes
  
  
• #40--Is the Tipping Point Cyclical, Secular or Both?
  How does this Influence the place of Real Estate in the Wealth Portfolio?
  
  
• #39--Anticipating Unintended Consequences or The Impact of MPG Efficiency on Inflation and Taxation
  
  
• #38--Supply and Demand for Homes is Different from Securities
  
  
• #37--Does Wealth Equal Freedom or Independence?
  
  
• #36--Could the “Stress Test” be a Big Trap?
  
  
• #35--Schooling vs. Education Charity Auctions vs. TARP and PPIP
  
  
• #34--Should We Appreciate Bonds? Part II
  
  
• #33--Relations and Correlations
  
  
• #32--Shrinking Discipline and Its Consequences
  
  
• #31--Should We Appreciate Bonds?
  
  
• #30--The Land of Re, Revisited
  
  
• #29--In the Land of Re
  
  
• #28--What We Can Learn from Mutual Funds
  
  
• #27--Lessons to all Investors from Warren Buffett’s Letter
  
  
• #26--Washington & the Necessary, But Insufficient, Signs of a Market Bottom
  
  
• #25--For the Greater Good: Frugality vs. Stimulus, T.A.R.P. and Foreclosure Relief
  
  
• #24--Financial Community Restructures
  
  
• #23--The Next Big One - FX
  
  
• #22--Searching for the Comfort of Cycles
  
  
• #21--Are There Big Traps in the Credits and Foreign Exchange Markets?
  
  
• #20--Did Fixed Income Confusion Create Madoff Victims?
  
  
• #19--Similarities in Picking the SUPER BOWL Winner and Fund Selection
  
  
• #18--General Misperceptions of “The Madoff Affair”
  
  
• #17--Correlations: Useful, Labels: Misleading.
  
  
• #16--Round Peg in Square Hole Produces Splinters
  
  
• #15--Four Aspects of a Four-Letter Word
  
  
• #14--An Attitude of Gratitude
  
  
• #13--Will 401(k) Miracle Help All Investors?
  
  
• #12--Reserve the Reserves
  
  
• #11--Augmented Unemployment Report Leads to Augmented Balance Sheets
  
  
• #10--Ultra High Net Worth Grantors & Charities: Plans “B”, “C” and “D”
  
  
• #9--Joe the Plumber and his Personal Financials
  
  
• #8--Turning Points Provide Hope for Everyone's Wealth
  
  
• #7--Fear is a Four Letter Word
  
  
• #6--Brilliance, Guilty and Bounce Back
  
  
• #5--Expect Unintended Consequences From This Weekend
  
  
• #4--Keep Your View Long Term
  
  
• #3--The Need for Speculators
  
  
• #2--Thursdays Down, Fridays Up
  
  
• #1--The Alphabet Bottom

____________________________________________
To Members of Mike Lipper's Blog Community:

For readers who would like to stay current on my uncommon perspectives regarding investing and world markets, join the community by subscribing, at no monetary cost, just your time and interest as well as occasional responses. Simply click the "To Receive Blog via Email" box on the left-side of the screen.

For those already receiving my blog by email, if you would like to recommend this blog to a relative, friend or colleague, the sign-up is located on the left-hand portion of the screen at www.MikeLipper.blogspot.com.