Do Current Prices Lead Future Markets? - Weekly Blog # 926

 

 

 

Mike Lipper’s Monday Morning Musings

 

Do Current Prices Lead Future Markets?

 

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

 

 

Lessons From the Weatherperson

With condolences to too many in the US and Europe this weekend, no snow came down in Summit, New Jersey today. The purpose of mentioning this is not to gloat, because we will have our share of bad weather in the future. The purpose is to remind all of the lack of certainty in predictions, and to remind all that the real value of weather-people is making professional investors look good!

 

I have one advantage in the securities analysis game, another title for predictions. My advantage is I learned analysis at the New York racetracks. The first thing was to read the situation, which included the conditions of each race and many other details. The purpose of this exercise was to eliminate races that were difficult to analyze. For example, younger horses with little to no experience, or a clear standout quoted at very small odds. Remember, my prime objective was to leave the track with more money than when I arrived, after expenses. A goal only a minority achieved each day. (This led to never wagering all on any given race and having enough money to get home. Thus, I am not fully committed in my current portfolio.)

 

The next task was to compare the records of the horses, which usually produced horses with the most wins or fastest times. This exercise normally produced a list with the smallest betting-odds, and they would generally be excluded because the payoffs were relatively small. So much so that they would not even cover prior or future losses. (This is like coming to a highly favored stock in a late market phase)

 

With all these eliminations, what is left? What I found at the track and later at my desk were bits of information in public view, suggesting that on a given day a horse could do well and beat the more popular favorite. (This was and still is my current hunting ground for investments.)

 

The Big Advantage

There is a big long-term advantage in selecting investments over picking horses at the track. When the day at the track is over, the game restarts the next time you enter the track. With investing in securities your investment progress passes through a number of phases. I find it easier to pick securities, which will have more up phases than down. The big advantage is that after an up phase there is more at risk than what you initially put in. If there are subsequent up phases, your returns are the product of your initial investment plus the return on other people’s money. A study of the returns of successful people captures this compounding impact. 

 

Applying The Track’s Principles Today

Enthusiasm is the enemy of finding current bargains. Most long-term investors, if they don’t get punished by high expenses, taxes, and selling large portions of their wealth quickly, have a good record of growing capital. However, if they get sucked into the market when most are enthusiastic about its progress, they become victims when enthusiasm shifts. The greater the number of transactions the greater chance they will not only have poor returns but will lack the capital and the guts to buy when securities are cheap.

 

The 2026 Shift

One month is hardly conclusive that markets around the world are expecting a different game, but the S&P 600 Small Cap Index led most other US stock indices with a gain of +5.61% in January. (If that rate of monthly gains were to continue throughout the year, the annual gain would be over 100%)

 

By comparison, if a January S&P 500 Index gain of +1.45% continued for a year it would produce another double-digit return. The problem is that it results in a four-year period of double-digit returns. (I suspect the doubling of one of the small cap indices is more likely than a four-year period of double-digit gains in the S&P 500 Index. Goldman Sachs calculated that if only 1% of the capital invested in the S&P 500 moved to the S&P 600, it would raise the latter’s price by 37%.) For perspective, of the 105 Mutual fund peer group averages, only 8 were up double digits.

 

Now To The Real World

In the last 3 weeks the usually slow moving ECRI Industrial Price Index came alive with successive weekly readings of 131.20, 126.28, and 117.67. The gain over all of last year was +11.50%. The three biggest price-increases this week in The Wall Street Journal were Natural Gas +20.64%, ULSD (diesel fuel) +12.16%, and Crude +6.78%. (I wonder what the present Fed and the probable new Chairman after May will do.)

 

There are lot of other worrisome statics out there. In a recent report Michael Roberts listed some 17 economic return elements that are worth looking at. I have selected just a few of them for you to digest.

1. Healthcare and social services generated more than 100% of net payroll gains in 2025. Top decile earners now account for about 45% of total consumption. (These top decile earners won’t be the beneficiaries of the tax changes in ’26.)
2. Softer demand for luxury goods suggests financial stress is beginning to move up the ladder.
3. Layoffs have reached recessionary levels and wage growth continues to slow.
4. Creditors are increasingly unwilling to lend at historically low real yields.
5. A recent PWC survey of 4000 global CEOs found that confidence in revenue growth had fallen to a five-year low.

 

Next Two Years

Odds are, the next two years will be anything but smooth. The key to surviving this troubled period is maintaining capital in diverse financial and other assets. Gather as many resourceful people as possible into your circle. Stay alert and get comfortable with change. Lastly, share your thoughts with us.  

 

 

 

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Mike Lipper's Blog: Failed Expectations: Do Details Count? Zig-Zag Flips - Weekly Blog # 925

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Mike Lipper's Blog: How Much Longer Can We Avoid Thinking About the Long-Term? - Weekly Blog # 923 

 

 

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It May Be Early - Weekly Blog # 898

 

 

 

Mike Lipper’s Monday Morning Musings

 

It May Be Early

 

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

 

 

 

A Usual Trap

A classic mistake in making future plans is focusing mainly on the present. In search of an investment policy for the next few years or longer, one should look at the causes of the main trends, not the size of the tariffs that have been announced.

 

The key force behind the announcements on tariffs is Donald Trump. His background is one of complex negotiations evolved from materially different views of how he sees the present and the future. I believe The President saw a critical problem of unfair trading terms facing the U.S. and saw a way to change the terms in favor of the country. He saw a way to solve the problem through meaningful discussion with the powers on the other side. The key was getting the right people around the table.

 

The core elements of unfairness are to be found in non-tariff trade barriers (NTB) erected by commercial interests with official or unofficial government support. (A number of examples were listed in last week’s blog, copy available.) While there is no published total of each country’s NTB effects, some experts believe their impact is twice the level of tariffs applied.

 

Mr. Trump’s way of dealing with foreign countries is to make the host nation an ally by using the size of US tariffs as a hammer. This is the reason behind the high announced tariffs, which is where President Trump expects the real bargaining to begin. I expect negotiations with major trading partners to take most of the summer. We may never fully understand the various changes to NTB’s, but a good clue will be changes to US tariffs.

 

Clearly there is another element to the aggregate size of the final US tariffs, the amount of cash expected to be paid to the US Treasury. This needs to be meaningful enough to keep the growth of the annual deficit acceptable to an unknown number of Republican Senators.

 

Most of these should be settled in the fall and early winter, so they do not unduly impact the mid-term elections. The economic background to the elections may be influenced by layoffs and the administration’s attempt to expand the economy. Additionally, further international actions may be the cause of how some state elections turn out.

 

The current crosswinds shown below may also impact the level of markets during this period:

1. After a period of outflows, T. Rowe Price is cutting staff.
2. Freight railroads are growing from China to Iran and Spain, for US continental trains, and other trains from Canada to Mexico.
3. Tariffs may encourage smuggling.
4. The latest weekly American Association of Individual Investors (AAII) sample survey showed a 39% positive and negative 6-month outlook.
5. A study of structural bear markets shows the average breakeven to be about 9 years.
6. The critical operating problems facing the US government is no different than those facing commercial and non-profit activities, a focus on effectiveness, not efficiency.
7. Jaimie Dimon has shared the following thoughts:

• Tariffs will be inflationary
• US reserve currency status rests on military superiority
• Markets are not low
• Lessons can be learned from the turnaround of Detroit and problems created (and elongated) during the 1929 crash
• Dollar weakness helps US multinationals 

As usual, I hope you will share your insights on the various thoughts expressed.

 

 

 

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Mike Lipper's Blog: Misperceptions: Contrarian & Other Viewpoints: Majority vs Minority - Weekly Blog # 897

Mike Lipper's Blog: Expectations: 3rd 20%+ Gain - Stagflation - Weekly Blog # 896

Mike Lipper's Blog: Analyst Calendar: Preparation for 2026 - Weekly Blog # 895

 

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Recognizing Change as it Happens - Weekly Blog # 876

 

 

 

Mike Lipper’s Monday Morning Musings

 

Recognizing Change as it Happens

 

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

 

 

 

Perspective is Difficult to Read

When gazing out a window while traveling in a car or a plane the view constantly changes, while the view within the vehicle remains constant, similar to the internal changes we experience while investing. Many of us are aware of both the outer world and our own investment perspective, although we are often unaware of the changes in people next to us. Rarely do we focus on factors impacting our own thinking during our travels.

 

Now may be a good time to review what is happening to those close to us, and even more importantly to ourselves. The following list of items crossed my consciousness this week, causing me to consider changes to our investments. In no particular order:

 

1. While I am aware of the US stock market trading volume growing, the rate of change between the 2 stock markets is telling. Over the last 12 months trading volume on the NYSE has grown +8.03%, while the NASDAQ has grown +57.39%. This indicates that there are two very separate markets. This was confirmed by Thompson Reuters’*, an old Canadian/British firm, through their actions this week. They moved their US listing to the “junior” exchange, which they identified as the home of technology companies.
2. The AAII sample survey had only 28.4% of their participants being bullish for the next 6 months, while 47.3% were bearish.
3. The Economic Cycle Research Institute (ECRI) industrial price index was up +6.44% over the past 12 months.
4. The Chinese marriage rate has dropped -20.5%.
5. JP Morgan Chase* announced layoffs for next year.
6. International Mutual Funds were the best performing group this week for the first time in a long time, led by large-cap growth funds.
7. The Financial Times is asking how big Walmart* can get.
8.  Until we actually see the final legislation and/or a court ruling, one wonders how the US will be governed. The US executive branch of government is in the courts for changes they’d like to make, after legal challenges.

I wonder how much longer the four international political leaders (Putin, Xi, Trump, and Moodi) will remain in power.

(* Owned in client or personal accounts.)

 

We are at a period in history where multiple large changes are occurring somewhat simultaneously, with significant consequences for winners and losers. Time is a scarce resource and that creates a sense of urgency among the participants. The following events bear close scrutiny as the outcome will be consequential for all.

• Change in US government – The power dynamic is being challenged in Washington DC and the courts, with a clear understanding that power could revert to the old order after the mid-term elections. So, Republicans recognize that change must be accomplished within the next two years. If the Republicans are successful, the country will likely see smaller government with some power ceded to the states. Smaller government should come with smaller costs, a plus for the national debt situation.
• Global government dynamics – Many governments around the world are grappling with similar ideological dynamics as those seen in the USA and are nervous about what might come next. This was on full display at the Munich Security Conference this week. The potential for trade wars could intensify significantly.
• Two wars have the potential to conclude this year, Gaza and Ukraine. Not all are likely to be happy with the outcome. Nor will there be unanimity among those shepherding the negotiation. Rebuilding will be costly in both locations, with no clear indication of who will pay and what deals will be struck to compensate those investing the money.
• Significant technological changes are likely in the next few years, with AI, robotics, and automation at the center of these changes. There will likely be big losers and winners, where the first mover advantage could be quite significant.
• An energy renaissance is likely, as the new technology driven future requires substantially more power than what it is replacing. The green revolution will not likely provide adequate solutions for the energy shortages. Natural gas and nuclear power seem to be the likeliest winners, as they provide the most consistent baseloads and the smallest CO2 emissions.    

Each of these bullet points has the potential to be disruptive. Having them all occur at roughly the same time will make for a challenging investment environment. While traders may be able to trade successfully, the odds favoring investing are declining for the next several years.

 

I would like to hear contrary views.

 

 

 

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Mike Lipper's Blog: A Rush to the 1930s - Weekly Blog # 875

Mike Lipper's Blog: More Evidence of New Era - Weekly Blog # 874

Mike Lipper's Blog: Roundtable Discussion - Weekly Blog # 873

 

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What I See and Perceive By Observing - Weekly Blog # 844

 

 

 

Mike Lipper’s Monday Morning Musings

 

What I See and Perceive By Observing

 

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

 

             

Often One Finds it is Difficult to Predict the Future 

I Currently find it particularly hard to predict the size and timing of the next recession. Economic news is sharply split between enthusiastic believers from discredited pundits and concerned business owners joined by the buying public. The index bulls currently appear to be winners over those focused on the near-term future, expressed through layoffs and a shift to more thrifty purchasing. 

 

During periods like this I find it useful to seek guidance from those far away from the worlds of economics and finance. Yoggi Berra was one of the most successful baseball catchers and later became a good manager of teams. He had a unique perspective derived from crouching behind home plate. One of his more well-known quotes is “You can observe a lot by just watching”. Using this mantra, the following observations may be useful. 

 

From the World of Numbers 

1. On Friday there was a significant difference between the percentage of rising and falling stocks on the two major US stock markets. Only 39% rose on the NYSE, while 63% rose on the NASDAQ. (This may indicate investors prefer shorter-term shares that are more speculative.) 
2. Extending the observations to a slightly longer period of a four-day trading week and shifting to prices, one get more balanced results. Fifty percent of the stocks on the “Big Board” rose, while 45% rose on the NASDAQ. (This shows that the general market is pretty much in balance.) 
3. Going out to a six-month outlook for the remaining half-year, the weekly AAII sample survey indicates an even more bullish than bearish bias, 41.7% vs. 2.6% respectively. It’s interesting that both indicators declined from the prior week by almost the same amount, 2.8% vs 2.2%. This is likely caused by a different group in the sample survey dominating. 
4. In looking at the list of equity funds that beat the performance of the S&P 500 in the first half. The three leaders were Fidelity Contrafund +25.6%, Vanguard Growth Index ETF +20.51%, and American Funds Growth Fund of America +16.80%. These three funds represent some of the oldest fund management companies and are the largest funds in the equity business. They also have three very distinct ways of managing money. Fidelity Contra is managed by a single manager and has wide latitude in terms of stock selection, with a turnover rate of 16 %. Vanguard Growth Index ETF has a very low turnover of 5% and Growth Fund of America has a turnover rate of 25%, which is below average.  Growth Fund of America is managed by a number of portfolio managers and the research department. (This demonstrates that there are several ways to perform well. The calculation of turnover is required by the SEC, which takes the smaller of sales over purchases divided by monthly average of total assets. The SEC was interested in identifying management churning the portfolio to generate commissions, so they only used the smaller of the two numbers. Thus, the real turnover is at least double the published turnover.)    

 

Observations in terms of People  

1. This is the year of elections, and the pundits are focusing their analysis on policies, which leads to inaccurate observations. The key is looking at the policies of the losers, not the winners, which is mostly the party now in power. In my opinion the losers failed to execute the solution to problems. One of the slogans ending Tammany Hall’s reign in New York was “Throw the Bums Out”, which is alive and well today against the “political class”. 
2. The media creates the experts they want to quote. The Wall Street Journal (WSJ) recently announced the last “bear” has left Wall Street, referring to Marko Kolanovic leaving JP Morgan. When I first read the headline, I expected to read about Jaime Dimon, the CEO of the most powerful bank in the US, if not the world. JP Morgan is a stock I own. In last week’s blog I mentioned the number of leaders of both commercial and industrial firms that have been preparing for the next recession for some time. (In predicting a recession, the exact date of the beginning should be separated from the probability and timing of the event.) 

 

 

Please share Your Thoughts 

         

 

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Mike Lipper's Blog: Preparing for a Recession - Weekly Blog # 843

Mike Lipper's Blog: Understanding the Universe May Help - Weekly Blog # 842

Mike Lipper's Blog: Stock Markets Becoming More Difficult - Weekly Blog # 841

 

 

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Bullish Chatter Leaves Out Useful Info - Weekly Blog # 826

 

      

Mike Lipper’s Monday Morning Musings

 

Bullish Chatter Leaves Out Useful Info

 

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

   

 

       

Public Service Announcement

Assuming you have been unable to avoid the bullish chatter from various media pundits and investment organizations, I will not repeat the positives on investments. Instead, I will file a “minority report” of little-known negative factoids to give some balance to your thought processes.

 

Layoffs Continue

Most publicized layoffs are from durable goods producing companies. It is the service providers that really drive the US economy, contributing over 70% to GDP when the service functions of manufacturers are included. When service companies encounter economic difficulties, they tend to cut back gradually rather than in lump sums. They are also less unionized and tend to provide fewer announcements. I therefore tend to pay more attention to the layoffs of service companies. That is why when Expedia announced this week that it is reducing its workforce by 9% it is worth paying attention. It is probably the tip of the iceberg above the waterline.

 

Rare Counter News

The senior strategist for JP Morgan Chase suggests we are in a period of Stagflation (slowly rising prices and wages). The clue to this analysis is the most prominent portrait in the White House main room where the current President meets foreign dignitaries and congressional leaders. It is no accident; the current White House occupant’s favorite President was FDR. In the second half of his term which converted a cyclical recession into a period of stagflation.

 

When the Public are Invited into what was Formerly Private, Beware!

Private lending has historically been conducted exclusively between a single borrower and a small number of financial institutions; all without the “benefit” of government review. Some financial firms are now offering pieces of private credit to the “unwashed” public. It is not only because some members of the public have accumulated cash, but also possibly due to federally sponsored inflation. Some believe there is now more risk in private credit than in the past.

 

Speculators are Buying More Than Institutions

In the latest week, 39% of the shares traded on the NYSE were at rising prices, with 60% on the NASDAQ going up. I suspect there was more institutional volume on the “Big Board”, with some having a longer-term outlook than the public or their advisers.

 

Be Careful of Labels

Many market prognosticators currently worry about the size of the gains chalked up by large “growth” companies, advocating for a switch to small caps. As someone who has invested in both individual small caps and more significantly in funds invested in smaller caps, I am concerned that the data used to support their long-term desirability is faulty.

 

Compared to larger stocks there is a problem with the data due to survivor bias, both for the winners and losers. Some wonderful or seemingly wonderful companies have had their history cut short by being acquired. At times, some of these companies are sought after because of apparently superior products, leadership, or customer base.

 

The sellers believe that the price paid compensates them for giving up some of their potential gains, but it also assumes it reduces their business and personal risks. Many performance histories capture their partial performance for the extended period in the published record, as the history of bankrupt companies is kept in the small-cap record. Additionally, the significance of the bankruptcy record is diminished due to their prices typically being much smaller than most acquired companies.

 

This data concern should not rule out investing in small-caps, although it suggests small-caps are neither a plus nor a minus for selection. Similarly, college selection should not be based solely on first grade class ranking.

 

Stock Selection vs. Portfolio Management

There are many ways to win or lose a football or baseball game. Some variables deal with the play of a particular contest, while others must consider the season, player development, audience development, funding needs, and the career progress of key individuals. Sounds complex!

 

A similar set of puzzles are used to solve the issues of stock selection and portfolio management. In this country, a large portion of the population has an opinion on how the game should have been played, at least for the audience. Predictability improves as one lengthens the time from a single game to a season. For companies, factors like the number of years, loyalty development, and careers might be important. In the fullness of time the last two periods are the long-term payoffs for the real winners, who are small in number but rich in experience and profits. For the most part, success can only be achieved through experience. There is very little written about how to achieve success.

 

Turning to successful long-term investing, the same complexities exist.  These are the problems I face in my life work. Producing these weekly blogs is one way I hope to think through the issues. Unlike some great investors, I limit my focus to individual equities and funds, excluding fixed income, commodities, and critical sources not in English.

 

You Can Help by Sharing Your Experiences, Particularly When You Believe I Am Wrong. 

 

 

 

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Mike Lipper's Blog: Caution: This Time Is Different - Weekly Blog # 825

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My Triple Crown - Weekly Blog # 783

 

Mike Lipper’s Monday Morning Musings

My Triple Crown:

Berkshire, Coronation, Derby, plus analytical insights

 

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

 

 

 

Berkshire Hathaway Annual Benefits

One of the advantages of owning shares in this unique company, both personally and professionally, is having the opportunity to learn from Warren Buffett, Charlie Munger, Greg Able, and Ajit Jain. The side conversations with a number of deeply involved investors and managers is an added benefit. For me, my wife, and my son Steve, this is truly an educational experience.

 

In terms of Berkshire, the following is a brief list of short-term (one year) comments:

1. The “float” is expected to be higher than in 2022. There should also be earnings from the railroad.
2. They have heavy property insurance exposure in Florida real estate.
3. GEICO will not be getting the full benefit of the switch to fully automate until at least 2024, possibly longer.
4. The stock is selling below “going-concern value”, suggesting it’s a good use of cash, particularly for heirs.

 

Coronation

While the coronation of King Charles III and Queen Camilla is important to many in the English-speaking world, it is also important to those of us entrenched in the investment world. King Charles produced a more modern version of the over 1,000-year-old coronation with all its pageantry and significance. Globally, he should give us hope we can remodel a financial system showing serious signs of disarray, with the inability to produce good value for all direct and indirect participants. Among which are the problems related to regional banks, commercial real estate, government sponsored inflation, inadequate education, inefficient healthcare, and getting the optimum benefits from layoffs. (More on the latter subject later in this blog.) We should learn what we can from King Charles’s discipline, especially his ability to make painful decisions with a clear view of a desirable future.

 

Kentucky Derby

The Kentucky Derby is America’s most famous horse race, which is unfortunate. The entrants in the race are 3-year-young horses with very little experience. This year’s winner, like many others in the race, had only raced 3 times and had only raced once at the Derby’s distance.  As most blog readers have learned, I believe whatever analytical talents I may have, I learned at the New York racetracks.

 

The payoff after both the tax authorities and track takes their share is important in figuring out if a particular horse is worth betting on. It’s a critical element of my handicapping skill, which I carry over to my financial analysis responsibilities. Not surprisingly, Warren Buffett also learned a great deal from attending local racetracks. One can see this when he explains the key to Berkshire’s insurance success, which is getting the right spread between the rate charged and the risk of loss.

 

One of the determents in this analysis is who you are competing against. This was an unusual Derby in that a number of horses were scratched. The betting crowd (the market) was left without a strong preference or favorite, much like one of the five largest market-caps in most sectors. At the track, the odds-on favorites are often 2 to1, or less. In this year’s race the winning odds-on favorite was 4 to 1. This should have been an alert to bettors that there was a low level of confidence in the crowd’s or the market’s choices. Somewhat similar to a number of market periods we have gone through recently. This filter might have suggested giving a more earnest look at horses with longer odds. Opening up the possibility of identifying a horse with 9 to 1 odds who finished first barely beating the second finisher, a horse with 5 to 1 odds. This type of behavior is why I often favor less popular investments, including small-caps and companies with somewhat blemished records. Particularly when there is a change of jockeys or other key managers. The keys to success in this type of thinking is not the win vs. loss ratio, but the number of dollars won or lost. Or if you prefer, Berkshire’s rate vs risk.

 

Analytical Insights

Hardly a day passes without the media reporting on a company with a new layoff. This is not newsworthy because of the number of people being laid-off, but because it’s happening during a period of high employment where there’s a surplus number of job openings relative to the number of people unemployed. Clearly there is an imbalance, or phrased another way, the people unemployed are different that those employed.

 

This condition requires careful and thoughtful analysis based on incomplete data. I suggest disaggregating the layoffs by presumed causes. The following is a list of types of layoffs and their significance:

1. LIFO (Last In, First Out) is usually directed by HR people from an easy date of employment list, without any further consideration. (I avoided one such occasion personally by going to a senior partner of an institutional brokerage firm which had 5 junior analysts. I pointed out that the likely salaries in aggregate were roughly equivalent to that of one aging but knowledgeable senior analyst. Perhaps my logic or guts worked, all five junior analysts were saved. I left the firm for another opportunity soon thereafter. Of the 4 that remained, at least 2 became productive firm partners.)
2. The opposite approach is sorting by perceived talent and keeping the best. In effect create a talent bank.
3. Friends for life. As I moved up, I recognized that some talented individuals did not fit where the firm was going. I suggested they find a better place and they became friends for life.
4. A layoff can be an essential part of a plan to move an operation, disposing of an activity that no longer fits.

 

Good analysts should try to determine which of the four alternatives most likely fits their described motivation. The LIFO layoff is only helpful in improving overall short-term productivity, as it does not make the remaining workers feel good about working for the employer. This may be unavoidable if the company is a union shop with built in official or unofficial rules governing layoffs. If so, the employer has deeper problems. 

 

In Conclusion

I had a good learning week, and I am happy to discuss my views with subscribers. Whether you agree or not, I can learn from you.

 

 

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Mike Lipper's Blog: Fire Drill - Weekly Blog # 782

Mike Lipper's Blog: Early Stages of a New Grand Cycle? - Weekly Blog # 781

Mike Lipper's Blog: Pre, Premature Wish - Weekly Blog # 780

 

 

 

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Fire Drill - Weekly Blog # 782

 

Mike Lipper’s Monday Morning Musings

Fire Drill:

On board ships and in schools, why not in investing?

 

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

 

 

 

Any Smoke?

Implications: US stock index returns are almost normal for the full year if we use the year-to-date performance of the Dow Jones Industrial Average +7.16% and the S&P 500 +8.14%. Even the NASDAQ +18.64% is representative of a good speculative year, perhaps benefitting from short covering. The VIX indicator is almost asleep at 15.76, compared to 30 in past mildly troubling times.

 

There are some whiffs of smoke in the air, including a continuing 2 to 10-year yield inversion spread of 4.08% - 3.45%. Updating one of the oldest technical indicators with a more modern twist. In the latest week the 30-stock DJIA had 20 stocks rising to 10 declining, but the 20 transports split 6/14. (In the original Dow Theory, it was only the rails in the index. Today the number of rails has dropped, and a number of airlines, trucks, and other transportation securities have been added.) This could be significant if the normal buyers of rails, which are freight driven, are looking for future declines. 

Another group that appears to be worried are the CEOs of traditional financial services companies. The latest to announce a 10% layoff from both their investment banking and investment management functions was Lazard. (Mid-market M&A industry revenues hit a 9-year low in the first quarter.)

 

Publishers Note

The popular distinction between a recession and a depression is your neighbor losing his job in a recession and you losing yours in a depression. It can be helpful to explore the possible roads to a depression by focusing on the needs of securities analysts regarding layoffs. In focusing on the way companies handle layoffs, they should first be aware of the lost art of making money from bankruptcies. All too often layoffs are the first act of self-inflicted worsening conditions. Since they don’t teach about surviving bankruptcies today, they are unequipped to adequately analyze layoffs. (I admit the thought came to me in a recent meeting with the Dean of an upcoming Business School, where there are no classes on bankruptcies.) 

While a Columbia College undergraduate I was privileged to take Securities Analysis from Professor David Dodd, who was both an academic and investment partner with Benjamin Graham. David Dodd collaborated in producing the seminal work on Securities Analysis based on their experiences in the 1920s and 30s. It occurred to me that the whole basis for the course was the knowledge necessary for those who’d lived through the depression. This knowledge could be important in the coming era, and I will consequently devote the rest of this blog to the types of things one should look for prior to and during such a period.

 

The Fixed Income World is Different

There are two critical differences between fixed income and equity.

1. The first is the legal relationship. Fixed income is a contractual relationship with an initial investment, periodic payments, maturity, and rank in the order of payments in a bankruptcy.
2. Owners of fixed income securities are expected to be paid a pre-determined amount of interest and pre-payments of principal, as well as a final payment.

If payments are not delivered as promised, the default process is governed by the issuing documents. Things change dramatically when a bankruptcy begins. All debts immediately come due, sourced from the potential sale of all assets. Debts are paid in priority order, as specified in the issuing documents.

 

However, compromises are often made to get agreement from the holders of different classes of claims. This helps expedite payments rather than having to endure long, expensive court hearings. The size of the payments is a function of the price paid for the assets, less the costs of the sale. The cost of the sale includes the cost of highly specialized attorneys, accountants, and other experts.

 

Fixed income securities rights and privileges are senior to common stock rights. Owners of common stock will probably be wiped out, as there is generally no additional money to pay out after the senior debt holders have been paid. However, to avoid long and expensive court battles by equity owners, they will often be awarded a small amount of a subsequent new equity class.

 

What is a Bankruptcy Worth

Up to this time the focus has been on the current appraised value, usually in a quick liquidation. To the extent there is a belief that a “going concern” will survive bankruptcy, a different kind of analysis is needed based on the current use of the assets and their user in the future.

 

Growing up in Manhattan there were neighborhood cigar stores on many commercial street corners. They were good business in the late 1920s and became less good as time went on. By the early 1940s those businesses had effectively died. A chain of these went bankrupt, but their stock went up in price!!! The reason for this was that these stores were on busy corners and had long-term leases. A classic case of being worth more dead than alive.

 

There were a couple of cases of railroads who lost lots of money throughout the depression and went bankrupt. However, a couple of sharp investors saw a similar situation, as the railroads had considerable land along their right-of-way. In the WWII expansion of plants and military camps, these lands and their proximity to the rails became very valuable.

 

The unfortunate attitude of too many of today’s analysts and portfolio managers is that “value” is found on the published financial statements. To them, stock selling at a discount to book value is a bargain. In truth, book value is a collection of unamortized assets not written off. Because of changes in the market for a company’s products, the use of their facilities is less than their original purpose. For example, strip shopping malls in poor locations today.

 

What is not reflected in the financial reports are the developed new products, self-generated patents, a good sales force, key employees, etc. These are the types of assets we look for as investments.

 

The items mentioned in the last paragraph are critical in evaluating various layoffs. To the extent the layoff managers husband these types of assets I am not concerned, but if they are shedding valuable assets I am.

 

 

How Do You Evaluate Layoffs of Owned Stocks?

 

 

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

Mike Lipper's Blog: Early Stages of a New Grand Cycle? - Weekly Blog # 781

Mike Lipper's Blog: Pre, Premature Wish - Weekly Blog # 780

Mike Lipper's Blog: 3 PROBLEM TOPICS: Current Market, Portfolios, and Ukraine- Weekly Blog # 779

 

 

 

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Short and Long-Term Opportunities with Risks - Weekly Blog # 593

Mike Lipper’s Monday Morning Musings

Short and Long-Term Opportunities with Risks

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

Mid-course corrections and structural changes represent both opportunities and risks. Opportunities and risks are rarely separate from each other. My process for dealing with each, travel along similar routes:

• Early, but not too early recognition. (Statistically there is not much difference from a discovery that’s too early and being labeled wrong)
• Identify the magnitude (Large to life-changing vs. time and reputation risk, which can’t be recovered)
• A research plan to narrow the number of opportunities and risks. (We can’t deal with too many variables)
• An initial plan of action (Casualty lists are full of those who were too motionless)
• Frequent adjustments to the plan. (Frequent but not too frequent, there is time needed for others to react reasonably)
• Listen to both extreme historians and futurists. (They are often the same)
• Create short-term achievable goals. (A passing grade is better than 100%, from which you can’t learn)
• Cut the losses when other opportunities appear with lower risks. (Most great discoveries/inventions are bi-products of research efforts seeking other solutions)

Subscribers could use the above principles in reviewing what comes next.

Mid-course Correction?
US stock prices since late July have violently fluctuated in a trading range, as measured by the three major stock indices.  At the lowest point they were about half-way to a normal 10% correction. As of Friday, they were within a good trading week to their former peaks, achieved in July: Dow Jones Industrial Average -2.05%, S&P 500 -1.56%, and NASDAQ Composite -2.73%. This blog is prepared for long-term investors and I am therefore not going to focus on the momentum driven traders that dominate the market these days, especially when long-term investors are nervously enjoying gains generated over the last ten years.

While the market and economies are not driven by the calendar, investors and the media tend to focus on annual returns. I am concerned that while most stock and equity fund investors have not yet reached a gain of 20% year to date, a large number have. I am wondering whether the market indices will go through their old highs with some enthusiasm, or whether they will be stuck in a price range with high volume, encouraging some equity investors to take some chips off the table and wait for the clarity they expect in November of 2020.

This is not a political judgement; one expects to see some damage from low interest rates and falling currencies. These investors should remain equity investors in stocks and funds, perhaps with some rearrangement of their choices. However, under no circumstances should they have less than 50% invested in the stock market, re-entry costs and tensions are high for taxable investors.

Fundamental Changes for Long-Term Investors
There are two very important changes that are likely to impact successful investing in the future:

• The appropriate nature of invested capital
• Fewer workers and more mouths to feed 

Adapting to the Changing Nature of Capital and Investing
The earliest identified capital included physical things like land, jewels, and weapons, etc. One could see them, and an experienced person could evaluate their worth. Thus, the earliest recorded loans were mortgages or collateral. The wonders of double entry accounting recognized an assets value as the residual of its depreciated cost. Thus, the earliest investors concentrated on collections of assets, which led to analyzing balance sheets. This may well be appropriate in a world where the physical reality of assets is well understood, but that is not the reality today and increasingly it will be less so in years to come. Over one hundred years ago JP Morgan, himself that as a banker, made loans based on a person’s character, not their collateral. Nevertheless, today we still group companies in terms of their manufactured products, while our politicians focus on manufacturing jobs and their related products.

The service sector has been more productive in the production of wealth than the manufacturing sector for some time. Matter of fact, most successful manufacturers are also good at providing service and arranging financing for their customers and themselves. I would certainly include salespeople as being service workers, both within and outside every business today. We have entered a low interest era which appears to limit profitability.  Some wonderful old companies having more physical constraints are producing well respected brands but have suffered sales and other problems leading to significant layoffs. Some of these workers will retire or leave the industry, others will go to competitors in much smaller and more specialized elements of their industry. I see this occurring in older tech, pharmaceutical, and financial companies.

For many years CEO’s have thanked their most important asset, their employees, in their annual report letter. Since recruitment has become an important responsibility of senior management, critical employees are identified as “talent”. To those who think about these things it creates a dilemma. Do we as customers continue to rely on highly respected brands, or do we seek out products and services from which organizations are supposedly attracting the best talent? We face the same question as investors, especially the choice of colleges for those with children and/or grandchildren.

As an investment manager using financial services stocks and diversified mutual funds from around the world, I deal with this problem daily. A good long-term investment in these arenas needs good portfolio managers, salespeople, and good administrators. It also needs top management who wishes to have these people and can manage them, which is not easy. The problem today is dealing with the layoffs. The Financial Times noted that trading and advisory revenues dropped 11% in the first half of 2019 for the 12 largest investment banks in the US and Europe. We have seen most of these businesses shedding people, many of which were servicing and supporting the investment and wealth management efforts, both for their own companies and external clients. The people I know are looking because they have been laid off, or because they see significant elements of decay in their shops and want a better home to practice their art. With these people I could produce the best investment team in the world, but it unfortunately won’t happen because these people aren’t capable of working well together.

I am currently focusing on a small number of turnarounds which have similar characteristics. In the past they’ve had some good performing mutual funds, good sales teams, and good administration that was largely done in house. What makes these potential turnarounds interesting is that they have retired their old management. They now have new management that is busy trying to hire the right people to run critical parts of their organization. While the companies I am looking at are publicly traded, the new top management is long-term focused and not looking to the next earnings report. Not all of them will succeed, perhaps none will. But if they don’t succeed in a reasonable time, they’ll not be able to attract the needed talent and will be forced to merge to save a limited number of jobs. Often the acquirers are not much better than the acquired, just richer. Some will be successfully turned around if they can benefit from what I see and show next.

Retirement is Necessary for Our Success in the Future
Barron’s had a cover story this week “How to Fix the Global Retirement Crisis”. It points out that in 2050 there will be more people over 65 than under in the US. Japan has already reached having 59% over 65, in the US we are at 38%.  I would suggest we need to find ways to keep able and willing people working. At the same time, we need to find humane ways to free up some of their jobs for younger workers who can do more with those jobs. Most of the time seniors are healthy and want to be active mentally and physically, if they have the financial resources to do so.

In some respects, the mutual fund industry is one of the luckiest of all industries. A substantial portion of its growth has come from external forces, usually the government looking after senior voters. In the US the federal government passed legislation which created individual retirement accounts, salary savings accounts (401k, 403b, and 457 plans), tax exempt mutual funds, and money market funds. Without these the fund industry would have been much smaller. Things are similar in other countries, but they’ve used different measures to aid their own fund industry. The leader is Australia, which mandates that 9.5% be contributed to superannuation funds, a number that is expected to rise to 12% in the future. If one combines that with a history of no recession for 28 years, future retirees can look to a sustainable retirement. Considering seniors vote more often than other age groups, one would think that the US government might address their needs.  This could even cause the interest rate of savings to rise to a level that would reduce future unemployment through sounder loans.

Investment Suggestions

1. Use the present market to clean up your portfolio of losers that are unlikely to soon return your cost.     
2. Focus new investments on companies attracting good talent.
3. Restrict brand buying to your consumer needs, not investments.
4. Be prepared for opportunities and problems.    

Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/09/excess-capital-less-equity.html

https://mikelipper.blogspot.com/2019/08/an-awkward-moment-with-frustration-not.html

https://mikelipper.blogspot.com/2019/08/short-term-recognitions-plus-longer.html



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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.