Introduction
While
securities analysts are essentially statistical historians, fortunes and
reputations be they financial, business, political or military are made by
change agents. Most of these changes are not self-evident initially to the change
agents, but come about through seeing what is and most importantly what isn't obvious.
Seeing what isn't is not enough for success. (Many of my security analyst
friends are frustrated by their lack of confidence in the stock and bond
markets because their valuation metrics are not working. They are not adapting
to the markets structures and valuations and may miss out for a time.)
What
is needed is a series of actions to create the somewhat poorly defined
solution. For most of those that are called brilliantly creative, it has to do
with adapting what already exists but re-purposing it for the new challenge. By
definition these change agents are future-oriented and not content with merely repeating
the past, no matter how cherished the past routes have been.
For
lots of reasons, I believe we have entered a period when we will see new
approaches to current problems. These approaches will cobble together some of
the past elements with new understanding of the implications of technology.
Learning
from the Military
The
study of war should be about how to conduct new military operations better than
the old methods. For many years the American Civil War was the classroom for
the German General Staff. They studied the campaigns of Stonewall Jackson and William
Tecumseh Sherman in particular. From them they adapted the concepts of maneuver
and column movement. They applied these brilliantly during the first and second
World Wars in Belgium, France, and Africa.
During
the period between the world wars, our own US Maine Corps developed both the Raiders doctrine and Personnel
Landing Craft as well as the use of aircraft for close tactical support for
frontline Marines. They were adapting some of what they themselves had studied
against indigenous forces and what was present in the era, but would also be
needed in the next global conflict.
Whether
BREXIT Succeeds or Fails May Depend on Adaptive Approaches
The
"Remain" campaign was based on the current economic factors. The
"Leave" movement was based on what the English saw and didn't
like. Assuming an unfriendly divorce,
the success of Leavers will depend on their ability to find new ways to make
their society and economy survive and grow. Much of the Remain pitch is that
the City of London, their one square mile financial district, will lose the
right to "passport" their deals into the EU. In Saturday's Financial
Times, Charles Leadbeater writes an article of five different scenarios for a
post BREXIT era. They go from the collapsed City to London becoming the best of
all major financial centers. The final one is dependent upon the people
involved adapting to the situation with new technology, but in some ways also a
throw back to the medieval Hanseatic League of northern, largely German Cities
and London.
The
Finance Minister of Luxembourg currently is warning the EU not to underestimate
the UK. I believe their success will be the Brits’ ability to change the game
by adapting some of the better practices and technology from around the world.
As a contrarian with lots of time, I would rather be a buyer than a seller now.
The new leadership is encouraging. However, as with all adaptations, there is
likely to be some mistakes, but the failure to adapt is likely to be worse.
“Equity:
The Film”
It
is said that men traditionally resist change whereas women by nature are forced
to be adaptive to change. One of the major corners of the financial community
that has lagged behind the publicly traded investment houses and banks has been
the Private Equity shops. Thus I am looking forward to the premier of a new movie
entitled "Equity" which is about a private equity shop with a
dominant woman. The financing for the
award-winning film was arranged by Candy Straight with twenty-five other
professional investment women. We have known Candy since her days of heading
acquisitions for a major pharmaceutical firm through a number of private equity
shops and as an independent director of several mutual funds. These women are a
great example of being able to adapt to difficult and challenging situations.
Large
Cap Investments
My wife Ruth and I both have had a long term
familiarity with the two corporate "Generals,”
General Electric and General Motors. As a young analyst, I spent most of one
year going through just about all of the major groups within GE. Ruth comes from Detroit and worked for a major auto
parts supplier and raised money from the Detroit business community for the
local symphony and local public television. Thus both of us have had a long
term familiarity with the two "Generals.”
At
one point I joked that the two should merge under the title of General
Inefficiency. Clearly for many years the Generals lived in their own world and
eventually lost earnings power, market share, and pride of place. But today
each is in the process of evolving and adapting to both their somewhat reduced
condition and also from more modern leaders.
In
the past when I saw GE in a fund's portfolio (it was widely held) I treated it
as an investment warehouse to store part of the portfolio until better
investments could be found. GM couldn't shake the cyclical tag, and was far
less owned by mutual funds, but was a comfortable holding for mutual insurance
companies and trust banks. Both of the Generals evolved financial subsidiaries
that traded on their parents’ credit rating and commercial relationships
without outstanding success except as a recognition of their size. Both of the
Generals today have evolved to somewhat smaller, but still giant,
multinationals that are producing earnings on a regular basis from most of
their activities. Both have benefited from adapting numerous of the business
practices of overseas leaders.
Taxable
Accounts Own Under 30% of US Corporate Stock
One
of the characteristics of the US stock market over the last several years is that
Large Cap stocks have outperformed the Mid and Smaller Cap stocks in price
appreciation but not in earnings growth. Their attraction has been a throw back
to the investment warehouse concept which is reinforced by superior liquidity.
One of the reasons for the superior liquidity in the face of declining trading
desk and floor capital is the shrinking direct participation of taxable
individual accounts. In 1965, which was after my year-long research on GE,
taxable accounts owned over 80% of US corporate stock. Today it is under 30%.
The more, relatively small players in a marketplace, the safer it is for those
in the center providing liquidity. Many of
the other Large Caps carry higher price/earnings valuations than the
Generals and are equally challenged to find growing revenues. With both the
Generals showing some signs of adapting to better business practices and
hopefully accounting practices, their relative positions in the Mega Cap world
could generate higher relative price appreciation from a historically depressed
price level. The main reason that the Generals suffered the prior price
declines (and in the case of GM bankruptcy) is their failure to adapt to
present and future conditions.
Two
Warnings
I
have been stressing the need to adapt. This is not to be confused with a need
to adopt. The difference is to add and modify one's own principles. Adoption is
wholesale acceptance of the adopted views. This may well be the difference
between a merger and an acquisition. Too often the second is one where the
acquirer takes no prisoners. The acquisition is to do things the way the
acquirer wants. A true merger is when both sides adapt to each other's thinking
and procedures and there is a melding into a successful marriage. This is the
exact opposite of the Broadway show with the title "I Love You, You’re
Perfect, Now Change." The key is not capturing but working with.
The
second warning is while I am optimistic for long-term investors, I am concerned
by what I believe is a consideration that sidelined investors are now coming
back into the market. For the first time in at least one year, many of the
financial media outlets are celebrating that money is rolling into mutual
funds. As usual, it would be useful to dig deeper. The entire gain in assets
came from Exchange Traded Funds (ETFs). Most of that money went into a few
fixed income ETFs. I believe the bulk of the ETF flow is from trading-oriented
organizations. By the way, four of the
largest transaction volumes on the NYSE this week were ETFs. The money going
into fixed income products now is unlikely to be long-lasting when interest
rates start to rise. Thus I am warning that the inflow is likely to be found to
be short-term rather than long-term investors.
Question
of the Week:
What
new approaches have you adapted to?
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© 2008 - 2016
A.
Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.
All Rights Reserved.
Contact author for limited redistribution permission.
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