Investors Be Alert to November’s Risk Lessons - Weekly Blog # 709

 

Mike Lipper’s Monday Morning Musings

Investors Be Alert to November’s Risk Lessons

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

In the US we have just celebrated Thanksgiving. Other countries also have typical harvest festivals where they are publicly thankful for personal good harvests. As a perpetual student of investing, I am thankful for the investment mistakes I and others have made, for they represent learning opportunities. We have an opportunity to not repeat mistakes by learning from them. Both George Washington in the American Revolution and Abraham Lincoln in the Civil War started off by losing battles. They came close to losing their wars, but learned well and changed their tactics/strategies. 

In my discussions with successful investors, I usually probe their mistakes, asking what they learned from them. They often mention that there was a factor in clear view that they did not fully appreciate. In general, these factors were not standard securities analysis issues, but some critical element that would have significantly changed the valuation of a security or market.

The month of November could be such a period where changes unfold that make a major difference. In most developed countries with active securities markets stocks sold at near or above normal valuations, with high-quality bonds selling at depressed prices. In most countries COVID-19 was highlighted as the major cause of supply chain shortages leading to rising rates of inflation, although they were usually the result of economies being stimulated with wide-spread grants. These excesses were tolerated, but they made owners of capital nervous. 

Political leaders recognized the best way to win the next election was to continue contributing to inflation, providing more money than the amount of goods and services available. In the US, the latest census will shift seats from urban centers to southern states in the 2022 election. Texas will get two additional house seats and Florida one. Both have strong Republican governors and legislatures, which probably means these three new seats will go to Republicans, with Democrats losing three seats at a minimum. Historically, the party that wins the prior Presidential election loses the next mid-term election in Congress, particularly in “The House”. Based on history, it is logical to expect Republicans to gain enough House seats to prevent the continuation of Democrat spending and taxation policies.

During early November it was rumored within political circles that President Biden wanted a second term, even while his approval rating was simultaneously dropping. At the same time anti-energy moves were pushed by the Administration, most impacting Texas the leading petroleum producing state. The attack on the energy industry continued this week with the tapping the Strategic Petroleum Reserve and the raising of the royalty rate for drilling on government land. (The Strategic Reserve was set up so the military would have a source of energy should foreign countries prohibit sales to the US). It is a bit ironic for this President to make these moves while seeing himself as FDR like. FDR prohibited US oil companies from selling their oil from Indonesia to Japan, giving Japan a reason to expand its drive further South in the Pacific.

In the second week in November portions of the US and European markets topped out, while China’s market was already in decline. This week a new COVID variant, Omnicron (B.1.1.529), from Africa emerged. It is growing very fast and has caused the suspension of an increasing number of international flights. While some may feel this is just bad luck (racing luck), the medical profession has expected new variants for some time.   

On Friday most of the World’s stock markets fell materially. In the US the popular stock indices declined between 2% and 3%. Some sectors were worse, with Health/Biotech falling 4%. A number of individual stocks also declined materially, with at least one falling by 20%. 

Does the abbreviated US stock market session on Friday give us a clue as to its future movement? Possibly, both the New York Stock Exchange and the NASDAQ traded 3.4 million shares on Friday. Ninety percent of the NYSE volume was in declining prices, with only 71% for the NASDAQ. However, the number of new lows on the NYSE was 9.5% vs. 17.2% for the NASDAQ. This suggests to me that further declines are needed for the NYSE to bring stock investors back into the market. It is possible buyers were purchasing options instead of stock and if that happens broker/dealers may buy additional underlying shares.

At this point I do not see anything that would turn sentiment for trading in the week ahead positive. Only skilled traders should try to ride the various bounces that could occur. Initially, US investors will likely follow the path of Asian and European investors, which appear to be muted. Patience may be rewarded.

Please share your perspectives privately or for attribution.

What do you think?

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

https://mikelipper.blogspot.com/2021/11/best-bet-more-sweaters-and-parkas-vs.html

https://mikelipper.blogspot.com/2021/11/lessons-from-london-mistakes-repeated.html

https://mikelipper.blogspot.com/2021/11/do-you-believe-congratulations-are-in.html

Did someone forward you this blog? 

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

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Focus for Investment Victory

Introduction

Often the most focused player wins the competition. (This is why years ago, I gave up golf, despite the occasional good shot, I couldn’t stay focused shot after shot and hole after hole.) I do try to be a keen observer of the investment game. Few, if any investors with a public record can stay intensely focused on all three parts of the game, I know I don’t. The three parts are: (1) Recency (a new word for many of us about the current picture), (2) avoiding mistakes, and (3) anticipation.

Recency

The media and therefore most individuals including many in professional roles spend their time on the headlines of the day. Far too often they make transactions going within the flow of the so-called news. This is somewhat understandable as they believe as most traders believe, that a security is exactly worth its current price; to which they add their impressions of the impact of the latest news element be it economic, political, corporate, governmental, or in some cases important sports results. While there are some skilled in the art of the trader, far too many go with the direction of market prices. I find that this is often a mistake as the market has already discounted the so called “new” development. Further, normal to enlarged rates of volatility cause quick reversal of recent transactions. As one goes with the crowd, bid and asked spreads widen plus commissions add to the cost of unwinding a trade. Our fund data does not directly capture these actual costs. However, with mutual funds and other professional funds, transaction turnover rate data is available. As I have previously mentioned there are a few rare individuals who manage money for others and have continuing trading skills. All other things being reasonably equal,  I tend to avoid high turnover rate funds. As each market segment and type of security is different, one should determine high turnover compared with a fairly wide sample of peers.

In our construct of four generalized time-span oriented portfolios, the Operational (1-2 year time span) and the Replenishment (2-5 year) Portfolios need to pay attention to current prices and near-term trends thus could tolerate some high turnover rate fund selections. There is no need for this type of talent in the Endowment Portfolio (5-15 year) and Legacy Portfolio (beyond 15 year to multi-generations). In a recent post  I suggested that a long-term oriented portfolio should increase its combined energy commitment from 7 to 10%. At today’s oil prices many of the energy related stocks have gained off of a recent bottom and some are mirroring the 20% rise in the price of oil. If this was a shorter portfolio I might start to be prepared to capture the gain off the bottom. But since, in my mind, this is a long-term portfolio in which I was prepared for a 20% further loss, I would continue to hold on to these cyclical positions for a number of years into the future.

Avoiding mistakes

This is the investment equivalent of the medical Hippocratic Oath of doing no harm. Today the investment application of this crowd-following doctrine is indexing or at a slightly higher fee level, closet indexing. Similar to the Prudent Man Rule proclaimed in the 1830 case that Harvard College lost; one should do what others are doing to avoid criticism and surcharge. This precept is based on the belief that the crowd is right, as demonstrated in securities indices. The weight of wisdom is now placed on the shoulders of the publishers of securities indices to make the right selections with the right mathematical formulas and updating mechanisms. I was able to build a reasonably successful business comparing funds utilizing Judge Putnam’s rule for my clients’ investments and more drawn to an earlier natural law first put forth some 41 years earlier. Benjamin Franklin in a letter written in French to a French scientist said in 1789,  “Nothing is certain except death and taxes.” Thus, I have difficulty locking my clients into a mechanistic formula.

Since we are looking at investing through historical lenses, allow me to bring up a major change to the way the investment community has changed over the last 40 years. On April 1st, 1975 the final element of the SEC-mandated end to fixed brokerage commissions came into force. The first element came into operation on December 5^th, 1968. A little background is useful in understanding the regulation which produced the opposite result than what was intended and has materially changed how the stock markets work around the world.

The official reason to introduce brokerage commission competition into the market, (neglecting that there already was vigorous service and capital competition) was to lower the cost for the retail public. A number of the traditional financial institutions like trust banks and insurance companies wanted to cut into the profits of brokerage firms who were attracting some of their best investment people to join  “The Street” at higher compensation than they were being paid. I will be happy to discuss with our subscribers how things evolved, but the key to this item is the twin recognitions that, excluding retirement accounts, there is very little retail listed equity agency business being done today. The traditional institutions have lost share of market to brokerage firms' wealth and asset management arms and to  the phenomenal growth in hedge and private equity funds. These newer players, through the use of technology, exchange traded funds, and borrowed capital, have introduced a much higher level of volatility and share price competition at the same time as the retail investor’s total investment costs have gone up. In the next major market decline the all-invested market indices are likely to have a fate similar to large war time bulk shipping at the introduction of faster, more accurate torpedoes.

Anticipatory investor

Perhaps it was my scanning the morning workouts at the local race tracks and the past performance records or some things that my brother told me about the Marine Reconnaissance training and battles; whatever the reasons I feel a need to look for what others are not seeing.  (USMC reconnaissance troops are now part of the US’s growing Special Operations forces.) One of the lessons that I learned was an understanding that in the Mexican-American War Robert E. Lee found a sunken (hidden) road by personal recon which let him to move his troops much closer to the fortified Mexicans than they were expecting and win an important battle. 

With these elements in my mix, I keep looking for what others are not seeing. Steve Jobs and other entrepreneurs do this regularly. While I do not believe anyone can accurately predict the future, I do believe that if one focuses on some of the elements that could change and locates some of the change elements, it will be the equivalent of finding that sunken road.

This anticipatory gene should play out on the Legacy Portfolio to produce a stream of income of multiple generations for the institutions and families (including my own) that I am involved with. To capture these results one must be patient. However, I am very conscious that to many there is no difference between being too premature and being wrong. That is why the great artistic masterpieces take a long time to develop.

Question of the week: Please share privately how much of your risk capital are you willing to invest in anticipation of change.

__________    

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.

Old Money vs. New Money Mistakes

One of the truths about investing is that to invest is to make mistakes. I am not suggesting that investing is an avoidable mistake. We have no choice but to invest our time, talents, and capital. The reason we have no choice is that these resources already exist in some form and if we do not change them, we are reinvesting them in their present forms. Innately, humans and animals instinctively know that our resources will deteriorate and perhaps disappear over time. Thus, we choose to do something with our resources. For most of us, we have no choice but to invest or attempt to improve our condition.

How we choose to invest is primarily a function of our experience. Our experience is not just what we individually have lived through, but also what we have consciously learned through the experiences of others with whom we choose to identify. Whether we like it or not, one of the inputs to our experience is our own DNA. This DNA is composed of elements of human race characteristics and more directly, family background. This is not to say that since there have been four separate (and not connected) Lipper brokerage firms, that for all time members of my family are condemned to be members of the New York Stock Exchange. What it does suggest is that we have a disposition to be attracted to transactions and services for others who transact. These tendencies can be applied to the various worlds of art and computer services among others. Luckily for the world, people are wired differently so we can find essential diversity in what we do. For the most part, our experience, no matter how formed, does not trap us into certain behavior, despite our propensities. Thus, as we enter each new theater of experience, we either treat what we are about to do as something new, or part of a continuum from the past.

Experienced investors, or if you will, old money, invest differently than those with new money. Each of us is human, and therefore makes mistakes; but often the mistakes of old money are different than the mistakes of new money.

Most of the old money that I know did not materially change the disposition of their financial assets after the experience of the last couple of years, even though their money piles are smaller. Their “normal” asset distribution might have been 5% in cash, 35% in bonds, 20% in domestic growth stocks or funds, 20% value stocks or funds and 20% international stocks. At the end of last year they may have had over 60% in cash and fixed income, 15% in value-oriented stocks or funds, 15% in international and 10% invested with a growth objective. An experienced investor believing that almost all relative performance is cyclical, might not change any commitments. For what the market takes away it will return over time. Further, from their experience, they believe after a major decline they should not change most managers or stocks of currently profitable companies. Old money has an affinity to long term records as they have had their money over the long term. They also generally prefer investing with organizations rather than in the success of any particular CEO or money manager. Thus, they chalk up the declines they have experienced as just a “normal’ cyclical decline which will be corrected by a “normal” recovery followed by some secular growth. In many ways this is almost a Newtonian view of a grand watchmaker overseeing our universe.

Owners of new money are full of themselves. They earnestly believe that their investment results are largely, if not totally, dependent upon themselves. They look at the current market always as an opportunity to show how bright they are relative to the mistakes of others. This personality-driven approach often identifies with specific hero CEOs or hot money managers. A somewhat over-simplification of their choices is that they believe in participating, if not leading momentum. Everyone recognizes that at any given time there are numerous unknowns that are likely to dramatically impact security prices and trends. If momentum won’t supply the answer, the new money is more likely to divine the right answers. They have more tools, or if you prefer gadgets, than the old money players and this give them an almost insurmountable advantage.

In these stylized cases, both the old money and the new money are making fundamental investment mistakes that others have committed in the past. Old money is betting on repetition, as in history repeats itself. If that was entirely true there would be no progress, as everything would circle back to our beginning point. In truth, history does show an uneven upward bias to the human condition and valuations. What many do not realize is that the upward bias is caused at least in part by the abandonment of failed, or too weak to survive, elements; as well as the pull of some new potential riches. Further progress is made by recognizing mistakes/opportunities. In the “old money” asset allocation example shown above, some wise investors might reallocate their money back to their “normal” portfolio. (There may be a seldom-declared advantage to this tactic: By increasing one’s commitment to a currently depressed area, if successful, the quicker one will get to the upper limit of the allocation causing a cut-back. One of the reasons for the dramatic declines in numerous portfolios last year was their over-investment in what was “hot” was not automatically corrected.)

New money often does not recognize that what is working so well now is very similar to similar beneficiaries of momentum in past market cycles. One of the many lessons coming out of the Great Depression of the 1930s was the peril of the extreme use of leverage or margin in the 1920’s by various utility holding companies, the great Goldman Sachs Trading Company and individual investors. Applying those lessons from the ancient past might have reduced the 2008 losses in various leveraged vehicles.

Both the stereotypical old money investor and the new money investor do not take into their considerations that they may be wrong. Their “system” like those of many disappointed race track bettors, does not contemplate that judgment mistakes are as normal as other accidents. Both set of investors can reduce their odds on big individual mistakes of judgments by using professionally sound funds. (Caveat Emptor: I manage portfolios of funds for institutions and a very limited number of individuals.) One might combine both the old money and new money approaches (using the asset allocation example above), by reweighting the equity portion of the account in favor of growth stocks or funds as momentum appears to be picking up in that direction. Another example of combining the lessons from these two habit patterns is taking the view that in terms of high-quality fixed income, it appears unlikely that interest rates will drop materially and therefore the capital appreciation potential from this particular segment is limited, and thus the commitment to high quality fixed income should be below “normal.”

Which kind of an investor are you old or new?