Preparing for the Future - Weekly Blog # 831

          

Mike Lipper’s Monday Morning Musings

 

Preparing for the Future

 

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

   

       

 

The fundamental job of an equity investor and manager is to grow current assets to fulfill future needs. Since we don’t know what the future will be or when it will be, we should consider a range of possibilities. My training at the racetrack and the US Marine Corps supports viewing the various futures through the various lenses of security analysis. I cannot think of a more difficult set of conditions than those facing us today.  

 

The possibilities range from the outmoded thinking of present world autocratic senior leaders (Biden, Trump, Xi, Putin, and similar) to unknown people with more scientific knowledge, but little management experience. To use an expression from the track, the odds-on-bet for the foreseeable future is that our present leaders will leave the scene relatively soon. They will probably be largely replaced by leaders two generations younger, who think differently and whose mental languages are different than what we have learned. 

 

Allow me to show you a mathematical approach from my world of mutual fund analysis. My old firm continues to report the weekly performance of mutual funds broken into seven investment objectives based on the securities in their portfolios. Most of the assets are in US Diversified Equity Fund investment objectives, which are divided into 18 peer groups. In the first quarter of 2024 there were 5 peer groups where the average performance was double digits. Interestingly, for the ten-year period there were 6 peer groups with double-digit winners. Four out of the six were repeaters. While all 18 performance peer groups generated double digit returns for the most recent 1-year period, only one generated double digit returns for two years two for 3 years, and 13 for five years. This suggests that immediately prior to the pandemic was a good time to invest in the average US Diversified Equity Fund. Accepting below average returns in the short term produced good results in the long term. This further suggests that picking the right year to sell an investment is more important than the right year to buy. However, as with almost every betting rule, the opposite can work. 

 

I believe you need to pay attention to the nature of the period when buying or selling. Investors in the US market should probably recognize that the average performance year is generally single digits, which should be evaluated relative to the performance of peers. Broader considerations should be left to double digit years, like now. Bet against the crowd if you intend to sell in a holding period shorter than five years.

 

Management Structure is Not Optimal 

The President’s cabinet is non-voting and is at best an advisory group. Large meeting tables of decision makers should be avoided, be they for political organizations, business, or non-profits (including educational and medical groups). The groups needing large meeting tables are not likely to produce dynamic results. President George Washington had a cabinet of 4 people, the secretaries of State, Treasury, and War, plus the Attorney General. Our present Cabinet has 26 members, 15 Department heads and 11 Cabinet level officers. 

 

Another Focus Should Be Updated 

 I don’t have the underlying data on our government leaders, but I suspect the majority have not spent operational and/or educational time in Asia or Africa. As a global investor I believe it is essential to correct this to effectively deal with the fundamental problems coming down the road. 

 

PS 

This week there have been a number of articles about the death of Daniel Kahneman, a Nobel prize winning psychiatrist and developer of behavioral investing. His basic premise was that investors are not rational and invest more for psychological reasons than sound investment reasons. This discussion may bring us back to rational decision making with your help.

 

Like most analysts and others commenting on investments, I have done the easy half of the job by supplying my thoughts on the buying function of investing. The much more difficult function is the disposal of investments, which is normal for the investment related committees of the two tech-oriented universities on which I serve. The reason for this one-sided effort is that making a buy decision is relatively easy.

 

By far the more difficult task is deciding to sell all or a part of an investment, which is a much more a personal decision and much more complex. The decision process should deal with some or all of the following topics:

• Likely reaction when other critical investors find out.
• Tax implications.
• Impact of the decision on the rest of portfolio.
• Dealing with beneficiaries.
• Legal aspects.
• Performance results.
• A least 10 other factors

I intend to share my impressions over time, with the thought that my audience of bright, experienced people will share their reactions. The reason I mentioned the groups of bright people I am connected with is that I learn how they approach various investment problems and use this information to address issues we all need to manage.

 

Next week, most of the blog will be devoted to an article produced by a brilliant well-rounded Professor from the Stevens Institute of Technology. The article explores how government actions had an unintended inflationary impact.

 

I am very interested to hear your reactions to this experience.

 

     

 

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Picking Winners/Avoiding Losers - Weekly Blog # 823

 

Mike Lipper’s Monday Morning Musings

 

Picking Winners/Avoiding Losers

 

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

 

     

Mindset

Every investor, speculator, analyst, portfolio manager, and politician’s job is to find winners and avoid losers. My fundamental training for accomplishing these goals for my family and others relies on my training at the racetrack.

 

The first requirement for success is recognizing where you are and periodically admitting when you are not right, which is distinct from being wrong. Right now, I admit I have been wrong. Using the S&P 500 index’s closing price performance on Friday plus a minimum 3% premium, WE’VE APPERENTLY ENTERED A NEW BULL MARKET.

 

This assertion is based solely on the numbers, although there is considerable short and long-term evidence to the contrary. Nevertheless, one lesson learned from the track is admitting your mistakes when holding a losing ticket. Learning something from your mistakes should often make you a winner. Mistakes are both normal and repetitive. The most valuable lesson is learning how to avoid them in the future.

 

Current Contrary Conditions

The latest stimulus for the market was surprisingly strong Labor Department jobs numbers, which probably disagree with the household numbers due to an increase in the number of people working two or three jobs. Perhaps more significantly, there were 601,000 more government workers than the 257,000 in domestic manufacturing. (Productivity is difficult to calculate accurately, and it is hard to value its worth. Perhaps the same could be said about the number of government workers.) Hardly a week goes by without an announcement by a large employer laying off 10% or more of their workforce. Those laid-off but receiving some settlement should not qualify for government pay. There are secondary layoffs which don’t normally get noticed, such as Abrdn cutting its use of Bloomberg terminals.

 

Longer-Term Worries

Structurally, we and the rest of the world are living more expensively. For the US it can be summed up on a secular basis. Total interest costs are already larger than defense and Medicare costs combined. An aging population with rising medical costs, fewer workers, and more expensive weapons, among other things is driving these expenses.

 

History does not exactly repeat itself but does rhyme. Technology changes, but the way people act rarely does. It is quite possible we have been in a period of low productivity and stagflation since the COVID years, paralleling the 1930s with some of the aftereffects of the 1940s. Hopefully we will not waste time and money trying to spend our way out of it, although current leadership around the world seems to be imitating those back then.

 

How to Invest

Recognize that the betting odds do not favor straight-line extrapolation. We individually will have to move cyclically and at times it will be unpopular with current opinion leaders. Some suggestions won’t work or will only work infrequently.

 

Targets of Opportunity

• Hospitals and Health Care will grow bigger, more complicated, and require management skills not frequently present today.
• Market popularity will prove to be expensive and will not last long. The gap between leaders, followers, laggards, and mavericks will be large. It will be difficult to consistently travel with the same people. Few, if any, can effectively work successfully up and down the ladder. Very little will be permanent, and it will come at a cost.
• Two lowly valued sectors, transportation and advertising, could be good opportunities for the talented.
• Also of interest are companies that have intelligently managed turnarounds, either by changing dramatically in size, location, or the makeup of their performance drivers.

 

Please share your targets and progress with me.    

 

 

 

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Copyright © 2008 – 2023

Michael Lipper, CFA

 

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Contact author for limited redistribution permission.

Three Portfolio Political Risks - Weekly Blog # 491

Introduction

What should be normal for an investor and particularly for a portfolio manager of other people’s money after a particularly good investment performance, one should question what can go wrong. Traditionally, September is the worst performing month of the year. Not only was it a positive month in 2017, but most of our advised accounts produced better than their individual performance benchmarks.  Since we utilize fixed income funds, both bond and money market funds as buffers to equity fund performance, most of our accounts are benchmarked against the Lipper Balanced Fund Index which is reported daily in The Wall Street Journal. The long-term record of that index is to produce returns between 5% and 10% with most of the time in the 7%-8% range and these are the normalized expectations for this benchmark.  We need to keep in mind that that past performance is no indication of future performance, and that investing includes the possibility of loss of principal.

Some of our clients’ investments were in mutual funds that gained over 20% and a few in the 30% range. These funds were invested internationally and/or invested in the top five stocks in the S&P 500 or their international equivalents. As we manage diversified portfolios we also own funds that did not do as well as the top performers.

I mention these results as a prelude to my natural caution; I am casting around as to what can go wrong.

What should be normal for an investor and particularly for a portfolio manager of other people’s money after a particularly good investment performance, one should question what can go wrong. Traditionally, September is the worst performing month of the year. Not only was it a positive month in 2017, but most of our advised accounts produced better than their individual performance benchmarks. In the first 9 months of 2017 we are producing returns at two to three times normal long-term annual expectations. We have invested some of our clients’ money in mutual funds that have gains of over 20% and a few in the 30% range. Following what should be the normal reaction after such results I am casting around as to what can go wrong.

A lot can go wrong. At the moment the three most prominent concerns all have a political base. As a classically trained securities analyst,  I normally ignore the political world, in part I have observed that contrary to most people’s logic, news follows the market rather than the other way around. For example the so-called Trump Bump actually started in July of 2016,  not at the election time. One reason for generally ignoring the shifting currents of the political world is that I am a securities analyst, more comfortable with financial statements and operating conditions than attempting to be a political analyst.

Nevertheless the three biggest risks to stock portfolios emanate from political decisions. Remember that Bernie Baruch when testifying before the US Congress was defending himself and his transactions that were labeled speculative. Reminding the Members of the derivation of the verb ‘to speculate’ was to see far (into the future). Recognizing that I may be wrong about any one or all three political risks, I will discuss each in order. The order chosen is in the probability of happening and the inverse order of magnitude of potential risk.

Risk #1:  Top Potential Casualties

Politicians strive much more for power than policy. In a capitalistic society there is almost always conflict between political power and the power of money. Often it is hidden but rarely is it not present. The battleground between the opposing forces is public awareness which is in control of selecting the levers that make our society progress. The following is an incomplete list of industries that the federal government curtailed through various measures since the aftermath of our very destructive Civil War, in roughly historical order. After identifying the industry or company in parenthesis are the government actions.

Railroads (Interstate Commerce Commission on tariffs); Life Insurance (licensing by individual states); Banking (Federal Reserve and Federal Deposit Insurance Corp.); Steel (tariffs and labor disputes); Standard Oil (trust busting); AT&T (breakup) and commercial airlines (deregulation). I am not suggesting that some of these actions weren’t in response to public concerns, but in these cases the net results were to force the companies to drastically change their ways which may or may not have helped the public more than it hurt them.

As a very powerful Speaker of the US House of Representatives once stated, “All politics is local.” In most communities the movers and shakers typically are a small group with a lead the following sectors: Banking, Newspapers, Auto or Farm Equipment dealers, Doctors, Insurance Agents, Retail trade and Real Estate. If a number of these feel threatened by new types of competition, they have an easy access to their political leaders in Washington - particularly when their regular political campaign contributions are remembered.

Today the five largest market capitalization stocks in the Standard & Pours’ 500 are increasingly being looked at as threats to the established  commercial and therefore political order. The five are Apple^*, Facebook, Amazon, and the two classes of  Alphabet (Google). Their combined market cap is $ 2.9 Trillion or in the same region as the annual incremental addition to the US national deficit. Clearly their very market successes create envy, both in the financial markets and public sentiment. Much more important in my mind is each of the leaders can be seen as an unintended threat to the cabal that runs our political structures on both sides of the aisle. I will very briefly identify the threats that can be conceived: 

^*Held personally

Apple is encouraging communications at numerous different levels which is destroying land line phone companies, local newspapers, and local financial institutions. Facebook in the last US election was the source of both valuable and manipulated news.

Alphabet (Google) is the ultimate supplier of “authoritative” information putting our teachers and professors to shame.

Amazon has just about destroyed the local book store and is seriously hurting the retail trade. Its very success has driven its stock prices up at a greater rate than the rest of the stocks in the S&P500, accounting for perhaps 25% of this year’s gains in some measures. It also is one of the reasons that active managers who own more of these and similar stocks are outperforming the identified indexers as well as the closet indexers. European governments have been among the first to try and corral these companies and could reduce their residents’ use of these products (which has happened in China.)

I don’t know how the political power class will attempt to rein in the power of the new uses of technology, but they may only be as successful as the Luddites in delaying the march of automation. While at the moment I am worried and expect the rumors or actual governmental moves to force a give up of some of the large stock price gains, I am betting that these companies’ lobbying and other efforts will blunt any serious moves.  However, my tolerance is perhaps at the 33% level. If your level of tolerance is less, be aware of the perceived risk.

Risk # 2:  Repatriation: Pandora’s Box

Be prepared for disappointing results from the temporary repatriation tax holiday. Politicians and to some degree central bankers are steps behind investors and corporations in their recognition that we are in a post-national world. A good bit of the foreign earnings of US corporations has been generated from sales of products and services to non-US residents. To the extent that the foreign branches and subsidiaries have paid for their US capital and research services, the foreign activities represent potential spin off candidates. This is the case for a number of multi-nationals.

If they fall for the tax trap and bring all of the foreign earned capital back to the US, they are probably good candidates for sale as they don’t believe in their own future particularly if the bulk of the repatriation goes to buy-backs which helps the existing management and hurts future owners.

Often when we invest in a foreign to the US fund, we are investing in foreign multi-nationals. This is similar to when non-US residents invest in our funds. In truth all over the world, most large financial institutions invest in large caps globally. They assume that the companies will be managed to achieve the highest prudent return long-term, not to solve local tax issues to reduce the size of unwise deficits. It may take awhile for the politicians to recognize that investors have felt the need to defend themselves from their own local governments, at least by diversifying into different legal and tax jurisdictions. Whether we like it or not we have entered a post-national world. One can expect the politicians to fight it and try to refocus investors on their home market, but it won’t work unless they encourage the locals to make their market the most attractive in the world. This probably won’t happen, unless we drastically shrink the size of government and regulation. 

The risk is that when repatriation for sound reasons does not produce the flow of money into the US that the politicians were expecting, the politicians won’t see that they are the crux of the problem. Most likely they will wish to penalize international investing, which will be counterproductive and hopefully won’t last too long.

Risk # 3:  Lessons from French and Russian Revolutions

The overall theme of recent elections in India, Great Brittan, US, France, Germany, and possibly Japan and Catalonia is that voters are angry as to their current position and want change. Many, if not most, of the current leaders were seen as change agents to solve the perceived deep problems. However, the problems are indeed deep and have been growing for forty to eighty years, Thus, they won’t be solved quickly in all likelihood. That is where the risk comes to the surface and the fearful lessons from the French and Russian revolutions. In each case the initial uprooting was led by a middle class leader who was attempting to fix the old system. It didn’t happen fast enough and there was some mismanagement of resources due to inexperience. In a short time the awakened masses lost patience. The mob or perhaps an organized crowd consumed the change agents and became enthralled with more radical leaders. For forty years I have been expecting a wave of change agents which could have come from either the right or left. If they can’t produce quickly, they will be replaced. The replacement can come from either extreme, but almost certainly will be extreme. This threat can only be headed off if the change agents get some quick early victories and start to come up with some extreme approaches themselves to head off more extreme approaches of the new radicals.

Question:

What are the three political risks ahead of us?        

__________

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A. Michael Lipper, CFA

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