Unclear Data Mostly Bearish, but Bullish Later - Weekly Blog # 870

 

Mike Lipper’s Monday Morning Musings

 

Unclear Data Mostly Bearish, but Bullish Later

 

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

 

 

 

First Half

Marcus Ashworth is one of the best market analysts who writes daily for Bloomberg.  In a recent piece he focused on volatility, with the following introduction:

The election of Donald Trump introduces an 

unwelcome capriciousness to US policy making,

with everything from trade to regulation to crypto-

currencies looking decidedly less predictable. And 

while the US consumer continues to defy expectation

by keeping the world’s largest economy rolling

along just fine, the rest of the world is a lot less

robust. Our key message for 2025: Buckle up, it’s

“gonna” be a roller coaster.

 

It is my own view that even Mr. Trump does not have a complete view of what is going to happen. As shown in the recent election of the House Speaker, members of both the Senate and House act differently than the majority of their party and will be paid off in some known or unknown way. Furthermore, going back to early American history, foreign powers will express their will and influence on our results and actions.

 

Chartists’ Views

We have heard many times that history does not repeat itself but often rhymes. One of the easiest ways to record the rhymes is through charts, which are often right as to future price moves. They have learned that future reversals can frequently be successfully predicted. The standard pattern for trend reversals is a “head and shoulders silhouette”. The three or more peaks with the center one being the highest shows each of the peaks declining to a common neckline. Currently, the two shoulders have hit their necklines and bounced up a bit. Most important to me, this describes the S&P 500 price action. If it breaks the neckline that indicates the likely chance of a significant decline.

 

Historically, significant declines often follow substantial increases, like those we have experienced. Declines often occur after valuations have been stretched like a rubber band. The measure I find helpful is the ratio of market value to book value. Currently, the S&P 500 ratio is 5.37x vs 4.58x a year ago. This seems like quite a stretch.

 

AAII

Many professional analysts look down on the retail market despite a reasonably good long-term track record. Like many others, it tends to be wrong at turning points. The AAII sample survey asks their participants if they are bullish or bearish for the next 6 months. I find the percentage difference between the bulls and bears of interest. The spread for last week was only 1.9% vs. 3.7% the week before. In each case the bulls were on top. My reading is that these investors are usually very intense in their views. The view they share with many professionals is that they are waiting, but don’t know what they are waiting for!

 

Other Straws in the Wind

Many of these relationships could change significantly:

• The bottom third of credit card holders are tapped out.
• The five best-selling car brands in the US are foreign.
• Only 44% of weekly prices tracked by the WSJ were up in the latest week.        

 

Most Funds Don’t Perform

There are 103 peer groups that I look at to see if they on average beat the S&P 500 Index fund. Below are the results showing the number of Equity and Equity Related Fund Groups that beat the average S&P 500 Index Fund for 1, 5, and 10 years.

 1-Year     5-Years      10-Years

   8            4               3

   

Just like following Professional Golfers, the ordinary weekend player can learn useful techniques, avoid many injuries, and enjoy investing.

 

Beware of Simplistic Data

It is popular to compare mutual fund gross sales to ETF sales, taking the difference as an indication of popularity. The problem is fund redemptions are built-in the day a fund is purchased. Redemptions for many holders is the completion of a planned period or condition, regardless of performance. The average age of a mutual fund owner is senior to when they initially purchased the fund. Many redemptions are also mandated by retirement vehicles, such as required mandated distributions.

 

ETFs are like buying individual securities. The buyer is often considerably younger and considers it a form of trading. To net these actions is like purchasing a car for dating when you need a car to get to work or to transport your family.

 

Question: Are there any topics you would like me to explore, or correct?    

 

 

 

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Inflection Point: “Trump Trade” at Risk - Weekly Blog # 862

 

Mike Lipper’s Monday Morning Musings

 

Inflection Point: “Trump Trade” at Risk

 

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

 

 

 

When Traveling We Often Don’t Know We Are Lost

As a portfolio manager for multi-generational accounts, it is critical to continually focus on the long-term funding needs of accounts, particularly when I am no longer around. In effect we are on a long march, which was part of my training as a USMC officer. (Most of our subscribers will read this blog on the 249th Birthday of The Corps) Rarely does a long march go in a straight line and each turn could be a minor change in direction. Alternatively, it could be a significant change in direction to avoid future danger. At some point a good Marine will recognize that we have passed a critical inflection point.

 

Our fellow investment marchers should be aware of a meaningful change in direction, speed of travel, and a different set of tactical moves. As an officer, it is my duty to consider changes.

 

Recent chatter from various investment pundits suggests there are various “Trump Trades”. Without making a judgement on each suggestion, I am willing to bet a year from now at least half those trades will not have worked out.

 

These trades are based on the 45th President’s actions and campaign comments. I believe no one knows what the 47th President will be able to get accomplished in his first year. We may think we know what he wants to do, but the world has changed both domestically and internationally and he doesn’t know for sure. Based on history, I am concerned about how Congress will follow direction. In many ways, both Chambers of the two major parties are split internally.  Just look at the number of announced caucuses and the potential number of informal voting blocks. Republican majorities in both chambers are likely be under 10 members. Furthermore, the incoming President did not do much to get many members elected. There are a number of Senators who see themselves sitting in The Oval office after the 2028 elections.

 

My portfolio management suggestions for protecting portfolio manager’s jobs are the following:

1. Divide the Trump Trades in half and hold one half for the next year.
2. With the second half, subdivide into twelve equal groups and sell one group each month for the next year.
3. Put the freed-up cash in an equal-weighted S&P 500 index fund if you must be invested, otherwise put the cash in a money market fund.

The above tactic is for short exposure but does not address the real problem.

 

Lack of Competent Leadership is the Problem

As a society Americans have become defensive about their own worth and their jobs. We seek to acquire the credentials that qualified us at some point in time for a particular job, “guaranteeing” that job and income. Once we have the credentials, we no longer need to compete. The longer the elapsed time from when we “earned” the credentials, the less talents we acquire. To offset this deficiency, we lean more on support staff. During WWII it required eight support people for every fighting man (mostly men).

 

This is true not only in the military, but also in medicine, government and schooling. (Note, I didn’t say education.) The larger the staff, the more bureaucratic the control systems get. (A classic example is the Ukrainian fighting people vs the Russian Army.) In general, the more people involved the less efficient the group gets and the longer it takes between promotions.

 

Our so-called educational system (school and university) has molded our workforce since the 1920s. The Communist Party thought that if they could control New York and other school systems they could impact the government, aided by the Depression. The key for union teachers was protecting their jobs by teaching-to-pass exams, both for teachers and students. They were not taught how to think. This strategy was remarkably successful.

 

These teachers trained many of the senior teachers who trained the senior college and university students of today, which explains the political efforts of the majority of teachers today. Trustees and Deans don’t control most of the critical choices of their schools. The faculty senate are the main decision makers, run on a seniority basis.

 

These are the people who are teaching the leaders of today and tomorrow in government, medicine, and business. They tend to favor large organizations, despite most progress in society originating from smaller groups.

 

Inflation is not the Problem

Inflation is society’s way of dealing with imbalances between current supply and demand. Attempts by a top-down government to control the urges of people to balance supply and demand are not useful. Every attempt to control these forces has enlarged grey and black markets, often summoned in regulated and expensive markets. Most supply shortages are due to government regulation for the benefit of friends of the government.

 

In Conclusion

If we have entered a new cycle, we may see a very different set of trends that we will need to understand and master. Any thoughts on how to manage long-term portfolios?

 

 

 

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Mike Lipper's Blog: This Was the Week That Was, But Not What Was Expected - Weekly Blog # 861

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Mike Lipper's Blog: Stress Unfelt by the “Bulls”, Yet !! - Weekly Blog # 859

 

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Dull Markets Are Dangerous for Investors - Weekly Blog # 683

 

Mike Lipper’s Monday Morning Musings

Dull Markets Are Dangerous for Investors

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

Why?

Not only because “quiet comes before the storm”, but dull markets give you the luxury of time for thinking and researching. Investors can use unhurried time to search for better investments and improve on the selection process, although most investors focus their energies on security selection. Some wise investors will ponder the processes used to manage their investment responsibilities, while commentators focus on the first group in the majority. As an investor for more than sixty years managing money for a limited number of investors and for my large family group, I am more concerned with the second need. Few pay enough attention to a periodic review of how we make decisions. Assuming you can make reasonable selection decisions, improving the decision processes will produce better results for the beneficiaries of your efforts in the long run.

Why Now?

Rarely can we assess in an unhurried fashion and review how we think about investing. We have such an opportunity right now. For at least the last six weeks the popular US stock market indices have been fluctuating within a trading range on relatively low and unconvincing volume. This is very logical if you believe equities are primarily priced on what they are expected to report in future periods, not what they have already reported. Expected future earnings are usually discounted at the current “riskless” interest rate of government bonds. Currently, many believe interest rates on US Treasury paper insufficiently discounts future inflation, pointing to the weakness in the valuation of the US dollar in multiple foreign exchange markets.

Others feel that after more than year of stock market gains it is time for a rest. Some point to the likelihood of not as favorable earnings comparisons after an expected large jump in the second quarter, especially when compared to the slow initial rebound in last year’s second quarter. Naturally, third and fourth quarter comparisons are expected to be more labored considering the 2020 recovery began picking up steam in the second half. (On the same basis, some believe earnings gains in 2022 will have tougher comparisons versus those in the coming quarters of 2021. Current spending plans for the rest of this year very much favor consumption with a lower investment value than productive capital expenditures.)

US stock markets are currently being held back by what one large US bank affiliated brokerage firm refers to as the 3 Rs= Rates, Regulation, and Redistribution. Some global investors, including those in the US, see foreign stock markets performing better than those in the US, as shown in the following table:

Stock Market Year-to-Date Gains

Canada        +20%

South Africa  +17%

France        +16%

U.K.          +15%

Taiwan        +15%

How to Improve Your Investment Processes

There are several ways to improve the various processes, unfortunately they require more work than  the sound-bite/pundit driven world would suggest. Often, the best communicator is more of a commercial success than a better investor. 

People like quick comparisons that lead to an ordinal ranking result, often leading to the identification of a leader at the peak of their performance. One of the more successful institutional investors, Marathon Asset Management, decries this approach in the following quote “categorization purposefully reduces complexity and nuances”.

Nuances are critical to the understanding of comparisons, no critical analysis of peers is simple and straight forward. The following is a list of categories: stocks, bonds, growth, value, return on sales, operating earnings, earnings per share, book value, and tax rates. On a personal level, what about our significant others, or the schools we chose to attend. What is missing in these comparisons is the attention to quality, sustainability, integrity, personality, and the fit within the existing structure or portfolio. I suggest statistical comparisons do not provide answers, although they are useful in framing important questions exploring the answers to the “soft” questions.

Another critical technique is to not pay more than once for the same positive. For example, the chance of success for a company developing a new product or service creating new customers and opportunities is generally priced into the value of that stock. However, that premium should be eliminated once the product is on the market and operating earnings from the new product are counted in current earnings. R&D is critical for many large companies to maintain existing earnings power, it is therefore not worth an added value.

Turnarounds can be great investments, but the key is understanding if they can keep adding value in the future or are one-trick ponies. Proxy statements are useful in this analysis. After a new CEO has been in place for about five years, the degree of senior management and director turnover provides a clue as to whether the heavy work of the turnaround is complete or ongoing.

While I would be happy to discuss other analytical techniques with subscribers privately, I will include one final critical analysis for portfolio managers. How a considered investment modifies the existing portfolio and at what cost.  A new investment will determine how the existing portfolio is modified and at what cost. Is the new investment going to reduce the chance of risk or add to performance in good periods? How much time will be needed to follow and deepen an understanding of the new investment? What is the appropriate starting position size and what are the likely points to augmenting the size over time? Are we comfortable with the other shareholders, both old and new?

Question of the Week: 

Have you modified your investment thinking in 2021? If not, are you likely to make changes before year end?   

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

https://mikelipper.blogspot.com/2021/05/faulty-comparisons-weekly-blog-682.html

https://mikelipper.blogspot.com/2021/05/extreme-views-can-be-good-lessons.html

https://mikelipper.blogspot.com/2021/05/where-is-stock-market-going-next-weekly.html

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Extreme Views Can Be Good Lessons - Weekly Blog # 681

 

Mike Lipper’s Monday Morning Musings

Extreme Views Can Be Good Lessons

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

                          

Historical Perspective

Both the Bible and other historic views are testament to very popular wrong views (the earth is flat) and unpopular views that eventually become popular based on their wisdom (the dignity of the individual). Consequently, it is wise to pay attention to extreme views, but not to necessarily accept them.

An Investor’s Perspective

There are times when faced with making pivotal investment decisions, I find it useful to examine extreme points of view. Currently, one could describe buyers, sellers, and holders as being uncertain what to do, following the reactions of others to events. They do this by thinking of their investments, both assets and liabilities, as a single portfolio. To the extent possible, I prefer to make activist decisions, accepting I will be wrong some of the time. (Hopefully, I will recognize my mistakes quickly enough and take corrective action. History shows I have made some decisions producing positive results.)

The Biggest Investment Decision

The core of every investment decision is an implied guess as to what the future will bring and none of us knows the answer with any certainty. Most investors spend the bulk of their efforts on the selection of individual investments: securities, funds, or advisors. My instinct is to divide most problems into separate parts, like the outlook for investments. Unlike most, I attempt to slice the question into reasonable time frames, examining the current outlook and various long-term market periods. Below is how I am looking at the stock market, at least through 2022 and possibly 2024, then to early the next century. In each case I evaluate extreme, not balanced views, highlighting possible insights.

The Current Malaise 

The pundits are beginning to recognize that we’ve entered an inflationary period, which is unlikely to be brief because it is the product of a number of trends. Firstly, the era of “big government” is back in many countries, states, and local communities. Characteristically, big government is  expected to provide solutions to various social and economic problems through large and long duration debt. This trend was aided by Volcker breaking the back of the last inflationary cycle where government interest rates peaked at about 15%. With interest rates below 2% today, the cost of servicing the expanding debt has been materially reduced. Unfortunately, much of the debt was used for current consumption, not investment that could have produced income or higher paying jobs. Increased regulation also caused numerous skilled jobs to be eliminated as critical capacity expansions were reduced. 

In reaction to these policies the private sector used technology and foreign labor to improve productivity, resulting in much of our clothing, food, cars, and parts being imported. Intense financial regulation has also caused non-bank lending to rise.

Equity investors have reacted by buying into companies and commodities that can raise prices due to supply shortages. Stocks in Canada have risen +17%, South Africa +15%, Russia +11% and Australia +10% this year. Commodity funds have had net inflows for the past 18 weeks.

US stock markets have declined slightly, led by the NASDAQ (the savviest market) falling -5% for the past two weeks and -2.34% this week. The following are other indications of a change in direction:

1. The JOC-ECRI Industrial Price Index fell slightly to 147.05 from 148.4.
2. The WSJ weekend price list showed 79% declining.
3. The American Association of Individual Investors (AAII) bullish sentiment reading fell to 36.5% from 44.3% last week. Bearish responses to the survey rose to 27% from 23%. (Historically a contrarian indicator.)

Perhaps the most significant signal came from T. Rowe Price (*), who believes global economic growth will peak this quarter (in percentage terms) and expects higher inflation. Consequently, they are underweight general equities, but favor “value” and commodities.

(*) T Rowe Price is a holding in our private financial services fund and personal accounts. 

Next Century Investing

Recently, I typed a report and hit the wrong key, writing 2121 instead of the current year. When I reviewed what I wrote, I realized we will likely have at least six members entering the next century in our extended family. Because I question Social Security making meaningful payments to the middle class and don’t yet recognize any six-plus investors entering the next century, I started thinking about them.

While it is probably untrue that Albert Einstein was the first to say that compound interest was the eighth wonder the world, he did recognize the power of compounding. (Ruth and I have stayed at the space that he may have stayed in on his many long visits to Caltech.)

Assuming as little as a 3% compound rate, after taxes and fees, the initial amount would multiply more than 10 times by the end of the century and 22 times if the net rate of return were 4%. For today’s exercise, how would I invest some money today or instruct a manager to invest without the ability to make changes for the next 80 years? 

While I believe people will continue to make mistakes, I assume there will be inflation risk. However, I would not invest in natural resources on a shortage basis. Nevertheless, I would invest in companies that could create sustainable demand for their products and services. Now, without to make future judgments, Apple (*) would qualify as a company able to come up with new products and services. I might possibly favor either or both Goldman Sachs (*) and JP Morgan, not for their existing businesses which are cyclical, but because of their willingness to lose money temporarily to establish themselves in new businesses that could replace their older businesses. 

(*) Current holdings in financial services fund and or personal accounts.

For the Single Portfolio

Many single portfolio accounts do not hold enough different securities to be intelligently diversified. Only those with 50 to more than 100 names could tolerate the risks involved in getting out of the center of the market. Thus, most should not own shortage plays, because they don’t last forever. They should probably own some successful foreign holdings in growing local markets with high savings rates. In terms of investing in new product and services companies, one should invest in large companies that have developed new products to replace existing lines, leaving the early development work to firms that can do it well.

I would be happy to discuss with you your thoughts on these subjects. 

What do you think?

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

https://mikelipper.blogspot.com/2021/05/where-is-stock-market-going-next-weekly.html

https://mikelipper.blogspot.com/2021/05/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/04/four-letter-words-to-sounder-investing.html

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Four Letter Words to Sounder Investing - Weekly Blog # 678

 

Mike Lipper’s Monday Morning Musings

Four Letter Words to Sounder Investing

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

When I was growing up I was admonished not to blurt out various four-letter emotionally driven words, which had the effect of me not using four-letter words at all.  I rarely focused on words such as love or nice. When I now think about communicating sound useful concepts to long-term investing, it strikes me that there are at least five four-letter words that shine a light on critical concepts. These are briefly discussed below in alphabetical order.

Debt

Debt is the temporary transfer of capital from lender to borrower in exchange for periodic interest payments. Both sides benefit from the exchange, the lender receives payment for delaying current spending and the borrower from using someone else’s capital. In a world where debt is growing faster than the growth of the economy, the question arises, is this a wise temporary transfer of capital?

From the borrowers’ viewpoint it should be about the amount of benefit received, be they individuals, businesses, or governments acting as an intermediary for taxpayers. Such as borrowing to invest in long term assets that will produce a stream of income larger than the interest and related costs. A mortgage on a business building is a good example.

Unfortunately, we are seeing more borrowing by both governments and individuals for consumption. One can look at much of the stimulus spending, which politicians hope will benefit them at the next election. Some may call these bribes, like the “bread and circuses” of ancient Rome, which at least built roads and bridges that produced a stream of increased traffic. 

When viewing any transaction one can often identify at least one winner, although this is not the case for high-grade debt today. The lender is receiving interest payments that will not fully compensate for the future decline in purchasing power, both in the national and international markets. (The JOC Industrial Price Index is up +108.81% and producer prices are up 12% year over year.) This may be why large commercial bank loans fell in the first quarter, even as deposits grew.

There is currently another problem with debt, the fastest debt growth is being financed outside of regulated banking institutions. The source being brokerage/investment banking firms and other financial companies. Margin loans to support securities transactions have grown 70% year over year. In well-managed brokerage firms, utilizing listed stocks and bonds as collateral is reasonably safe for the lender, who can recover from some of their clients going broke. However, there has recently been a surge of borrowing to leverage non-listed derivatives tied to relatively illiquid stocks listed globally. The question facing the market is, are we approaching a crisis like the Morgan Library Panic of 1907 where the banking community was forced through locked doors to contribute to endangered competitors? The problem would likely be socialized with government bailouts today, adding to the growing deficit by partially financing it with more debt. Bottom-line for most institutions and individuals, debt is not currently priced for the long-term inherent risks.

Risk

Sir Isaac Newton came up with a critical rule, “There is an opposite and equal reaction to every action”. Too bad he did not offer an investment rule for his own considerable fortune, suggesting every investment caries both rewards and risks throughout its existence. There is no such things as a riskless investment. The key to assessing the size of a risk is what a knowledgeable, disinterested, investor would pay for an asset producing an acceptable rate of return relative to all other investments. This may be the reason that on the more actively traded NASDAQ the number of stocks rising was 8.5% vs 5.8% falling, compared to 18.4% rising and 3.2% falling for the NYSE. 

Rate

Rates tie streams of numbers together, like miles per hour. Most of the time in the investment world the two streams relate to interest rates, earnings growth, sales, and book values compared to prices. The wise investor adjusts the first stream for the probability of it continuing the current movement. The price may also need to be adjusted for the likely size of the investment. (Remember, quoted prices are for small purchases, take-over prices are normally higher than pre-bid prices.) 

Rank

Rank is an orderly display of participants based on criteria such as length of period, size, volatility, etc. One should remember there is nothing that promises the sustainability of completed periods. The winner may have been slowing down or speeding up immediately before the end of a period. Also, first place gives no indication of any negative event impacting one of the participants, which may not reoccur. While repetitive high rankings are assuring, it is not a guarantee of future results. In picking funds or stocks, you need to adjust for the change in skill of each participant. Because conditions change, one should not place too much emphasis on repeated success. Remember, winning streaks almost always end.

Time

By far the single most important variable in choosing an investment is the period to be measured. Unless an investor believes they have superior trading skills, they should focus on one or more time periods. The longer the period, the more likely the return will be smaller. The number of full participants will also decline through acquisition or failure. 

The following set of observations may be relevant in applying attention to today’s details:

For the current calendar year through last Thursday, the best mutual fund macro peer group was US Diversified Equity Funds +12.02%, followed by Sector Equity Funds +11.96%, Commodity Funds +11.59%, World Equity Funds +6.82 %, and Alternative Equity Funds +1.84%.

Keep in mind that this data is for almost one-third of a year. The 12% return for US Diversified Equity Funds and the +9.53% return for All-Equity Funds is close to the long-term stock average of +9-10% per year, which excludes fund expenses. This raises the question of whether an investor should stick around for the rest of 2021. If you were to stay invested this year, a contrarian might invest in the average World Equity fund, which has generated roughly half the gain achieved by US focused funds. Of the 25 best performing mutual funds this week, 10 invested in the China Region. A leading broker noted that investors were buying European Equities, inflation-oriented investments, and “value” stocks. They were selling high yield and emerging market securities. (Note that the five largest tech stocks have a combined market value larger than all the emerging market stocks.) 

Most large gains by investors result from holding stocks and equity funds for a long time. An example of the effect of compounding is the US Diversified Equity Funds return of 12% doubling in 6 years. (Which assumes an annual return of 12%). If the compounding rate were 9% it would take 8 years and at 6% the doubling would take 12 years. 

We rarely live in an average year. Based on history, roughly two-thirds of the years rise and one-third decline. Because of the compounding effect investors have more money in their accounts than simply multiplying decades of average performance. Results can be very satisfactory. Hopefully we will recover from increased “rates, regulation, and redistribution” in the future.

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

https://mikelipper.blogspot.com/2021/04/the-other-side-weekly-blog-677.html

https://mikelipper.blogspot.com/2021/04/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/04/respecting-opposition-market-weekly-bog.html

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Contact author for limited redistribution permission.

Is GameStop the Missing “Event”? - Weekly Blog # 666

 

Mike Lipper’s Monday Morning Musings

Is GameStop the Missing “Event”?

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

In the “Bubble”, Seeing the Trees and Not the Forrest

In recent blogs, I examined evidence of a stock market bubble about to burst. Is this week’s explosive coverage of the short squeeze battles of a handful of relatively small stocks, the classic unrelated event that leads to actions triggering the rapid deflation of general market prices? Could be, and it is worth thinking about.

Markets regularly fluctuate between high/low prices and valuations. Most of the time, they stay within an envelope around a loosely defined center. This is the type of period where stock and fund picking produces relative good and bad returns, getting the attention of both individual and institutional investors. The game dramatically changes at the two extremes. At both ends the driving force is the actual level of liquidity in the marketplace. The relatively few stocks that have high, two-way market volume get most of the action and attention. The others either don’t trade or have significant price gaps between trades. The deflation of a bubble is when prices rapidly collapse.

In the prelude before the bubble breaks, there are often signs of structural deterioration preceding some seemingly unrelated event, which spurs reactions. This can be the telltale sign of a bubble breaking. Two examples of these events come to mind. The assassination of the Austrian Archduke and the passage of the US Smoot-Hawley Tariff Act of 1930. In both cases, from a global standpoint, they were not earth-shattering events, but the reactions to them led to World War I and the global depression of the 1930s. 

In both cases, various political leaders used the event as an excuse to make aggressive moves, resulting in tragedy. The murder of the Archduke and his wife became an excuse for aggressive, militant nationalism and an attempt to change the political structure in central and eastern Europe. It in turn eventually brought the US reluctantly into the war and was a contributing impetus to WWII. 

The Smoot-Hawley Tariff was a political attempt to bail out the highly leveraged farm sector in the US. It raised import tariffs on agricultural and industrial products by 20% and was quickly followed by 20 other countries.

Possible Application to the GameStop Short Squeeze

Very little of the popular media coverage on the short squeeze of GameStop and a small number of other stocks starts with the recognition that short selling requires a margin (loan) account, funded by cash and/or securities. The buyer of the shorted shares looks to the selling broker, or in some cases a bank, to supply the shares. This requires the broker to borrow the shares from other shareholders or purchase them to make the delivery. If the broker borrows the shares, the firm must pay a rental fee or find another customer who owns the shares. To facilitate the trade, margin accounts permit the broker to loan out shares in margin accounts, using them as collateral to raise capital to support transactions. 

The broker is often forced to buy shares in the market to make delivery in less liquid stocks. The mere fact of the broker buying pushes up the price, turning the broker into a short seller, having delivered the newly purchased shares. The broker must recapture the money it spends and occasionally if it borrows too much it may face forced liquidation of the firm. If this becomes the experience of many, there can be an effort to get the regulators to declare a “corner” in the stock, where they order the cancellation of all trades above a given past price. It thus wipes out some of the gains of the short sellers and reduces the losses of the brokers. (This has not happened in many years.)

How Did this Happen?

1. In a period where there are large operating business losses, there is a political impulse to bail out the unfortunate to secure their future votes. To the extent the bailout is not quickly repaid with interest, it is in effect socialized, making the profitable portions of the economy pay the losses and any shortfall in repayments.
2. Payments to individuals during the current pandemic where in many cases saved and not immediately spent.
3. Many states have legalized both sports and casino gambling to tax it. This probably enlarged the gambling population and transferred public wealth to gambling interests.
4. Currently, many are working from home (WFH) and sitting in front of their computers. Some have temporary cash to spend and in the absence of their normal sports betting vehicles they have developed trading relations with electronic brokers. 
5. Our educational process in schools and at home does not distinguish between gambling and investing. Furthermore, people and many politicians don’t differentiate between borrowing to meet current expenditures and capital invested in long-term assets. Long-term assets, like new plant or other capital expenditures, create new earning assets which in many cases become new collateral.  

What May Happen?

1. The popular media will likely produce numerous stories of individuals with losses. This will provide politicians with an excuse to produce more regulation, which will be expensive and send more investment overseas, and/or into non-public activities.
2. The future “Debt Bomb” is now in the hands of the government, but with the shrinking share of the loan market at banks, credit conditions will loosen and the private sector debt burden will grow. Underlying every major collapse is the extension of too much credit and the resultant leverage. 
3. We live in a dynamic globe. Most financial systems are quite extended, with little room to handle medical, weather, technology, military, and political surprises.

What to Do?

For those portfolios structured to meet payment responsibilities over the next five years, this would be a good time to prune portfolios. The following actions may be appropriate.

1. Create a schedule to recognize all loses serially between now and June 30. Thus, create a capital gains shelter for sales of winning positions.
2. Examine winning holdings that need a current bull market to reach the investors’ price objective.  Sell at least half.
3. Sell at least half of all positions in stocks where current management’s decisions seem inappropriate.
4. Build an opportunity reserve for two new purchases.
5. Increase exposure to stocks that trade beyond your home market.
6. Expect surprises and usually invest against the first identified decision.
7. Read carefully what companies say. One Dow Jones Index company expects earnings in 2021 to equal those reported in 2019. Even if that happens, the company will not have produced sufficient earnings to cover the then expected growth rate for the two-year period, leaving their growth at least 10% behind the original plan. This should cause one to make some changes, either to the portfolio or to expectations.

Working Conclusion

Become more engaged and start managing your portfolio, holding a collection of investments that can both absorb some losses and find new opportunities. 

What Do You Think? 

 

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Short and Long-Term Unseen Implications

Introduction

Being solely a contrarian is insufficient to be a competitive investor. There are instances when the majority is correct. To improve the contrarian's odds the search for seeing elements that others don't is essential.

Since the presidential election there has been a dramatic blast of enthusiasm for US stocks and a disdain for high quality bonds and emerging market securities. While the positive effects of rising interest rates have been present for a number of months, the equity acceleration began almost immediately after the election. One might be accurate in believing that all those who were so wrong about the outcome of the elections at every level were attempting to play catch-up by doubling down their bets. In both cases their views were narrow and lacked fundamental knowledge.

Early Contrarian Training

In the 1960s I was a journeyman electronics analyst. The technology to produce color television had been known since the 1940s if not before, but the projected retail cost for a set was over $1000. My analyst peers focused their time on getting up to date on all the technological advances in components for the set. Unlike them I spent time with the marketing research people of the major set producers. In turn, they were very focused on how middle market consumers were spending their money. By the mid to late 1960s, the portion of consumers’ budget devoted to auto purchases had peaked as the post WWII replacement surge had peaked.  Thus they were ready to buy their first color television at prices over $600, and some up to $1000. That perception allowed me to be early in recommending color set producers and some of their component suppliers before my more technologically-oriented competitors were waiting on new breakthroughs.

There are Two Important Elements the Enthusiasts are Missing

The people that were so wrong about the Republican surge in the election are making the same mistake again. They are taking what Donald Trump has been saying as a concrete plan for his and the party's actions, just as they misread the polls for two generations wanting an outsider to have someone to listen to them. It didn't matter whether they were on the right or the left of the political spectrum. To some extent Mr. Trump's fellow elected Republicans have not fully accepted the implications of the recent elections.

The issues for the Republicans comes down to how they will vote and how will they manage their attempts to "drain the swamp." I believe (somewhat naïvely) that the investment bulls believed explicitly in the words of the candidate and President-elect in terms of both corporate and personal taxes. One needs to remember how tax proposals become laws and regulations. The House Ways & Means committee, after what will be strenuous debate, will eventually report out a bill to the full House where there will be further debate.

Any reductions in the net tax realization of revenues will increase the size of the deficit unless one accepts dynamic scoring that suggests that tax reduction will expand tax revenues through growth. The political problem facing the Administration's desires is in the House where there are a significant number of Republican deficit hawks who probably feel that they can not get re-elected if they vote in favor of an increased deficit. It is quite possible before a tax bill can pass the full house some Democrats will need to be in favor of it. Traditionally this support is purchased with some very specific policies favored by the Democrats which the Administration would have to signal approval. Subsequently the Senate will pass it's own bill setting up a joint congressional committee to work out the differences so that both Houses can approve the legislation. Both houses' majority leaderships will appoint members to the conference committee from both parties. These will likely be their most senior tax aware members. Eventually a compromise bill will be agreed to in the small hours in the morning between as few two members and a small number of their staffs. Due to their exhaustion and some lack of familiarity of the wording of tax regulations, the committee will get help from selected lobbyists from the deepest part of the swamp  will suggest the actual language to be used.

At this point hopefully the majorities in both houses will vote to pass the tax bills on to the President for enactment. For the investment bulls to believe that they can guess both the timing and the actual impact of the legislation on specific corporations and individuals is naïve. 

In many ways the easiest part of the governing process will be the passed legislation. Particularly for the incoming Republican cabinet the much more difficult process will be the actual administration of the ensuing regulations that the multi-generational government workers will write and administer. Just look at how almost every government body is actually managed by career people from "the swamp." Good luck without substantial help from "K Street" lobbyists to guess the actual implications for various taxpayers.

The chattering classes are assuming that by a swipe of the pen the President can in the long run effectively change regulations through executive action. Regulations were initially put into place because of perceived problems; some valid problems will need to be addressed for the protection of certain groups. The tradition in government is that even when totally free market people are put in place they will drift to the bureaucratic tendencies of command and control policies. In all likelihood those that will be actually administering the regulations at the local level will believe in the command and control philosophies.

The Second Misreading

The general rise in stock prices in many markets is being taken as the public' s affirmation of the results of the election. I believe that far too many people are not looking carefully at the underlying data and drawing, at the moment, the wrong conclusions. Most of those that wanted to be labeled "the smart money" were totally convinced that the US would have its first female president. Recognizing that probably meant at best a continuation of slow growth in a market that was close to being fully priced on election eve. They were short the market or  at least a number of stocks. When they woke Wednesday morning these "investors" became traders and quickly attempted to cover their shorts in a relatively thin market at higher prices. Soon thereafter to make up for their losses they went long the stock market and short the bond market.

The faulty analysis of the US stock market, at least in part, was due to the headlines that mutual funds received substantial inflows and therefore would be heavy buyers. As usual people should carefully examine the underlying data. The quoted numbers combined traditional mutual funds with Exchange Traded Funds (ETFs). Utilizing the data from my old firm, one could see that for the month of November traditional US Diversified Equity funds had net redemptions of $+38.6 Billion  up from $+22.3 Billion in October. On the other hand for the same types of equity portfolios,  ETFs had net sales of $+33.2 Billion up from $+11.2 Billion on October. Perhaps, even more significant ETFs investing in specific sectors had net inflows of $+13.4 Billion up from net outflows in October of $-1.3 Billion.  

The significance of these divergent trend is that due to the length of time many traditional mutual fund holders have owned their funds they are approaching a period of their lives that are choosing to either becoming more conceived conservative with their money and/or their need for cash has been rising. Judging by the volatility of ETFs transactions most of the transactions are from trading entities often hedge funds or professional traders. Some of their transactions are part of "pair" trades where they take a position long or short on a specific issue, but also hedge either general market or a sector against their primary choice to reduce general market risk. Thus, the main motivations of the owners of traditional mutual funds and ETFs are in terms of likely timespans of their holdings are different. Mutual fund holders own their shares for more than four years, often for twenty, where as the ETF holder is probably focused on the month's or quarter's performance.

Thus, I do not believe that there is a general affirmation of the policies of the incoming administration at this point.

Short Term Views

It is quite possible that this last week was something of a mild turning point in the market. Each week I look at the mutual fund performance of our clients' fund positions. I compare their quintile rankings versus their perceived peers. In most periods for most funds there is relatively little movement. However, among the many funds we follow, in this week, eleven of our funds (after doing among the best in the four weeks ending December 8^th) did relatively poorly in the week ending on the 15th. On the other hand we had four funds that materially beat their four week average. What this pattern suggests is not that there were materially changes in the funds' portfolios, but that the market is questioning the very recent strength.

In a piece on the views of ten well-known investment strategists picking their favored industrial segments, eight picked financials which clearly have been doing well. As a portfolio manager of a private financial services fund, this near unanimity of opinion makes me nervous. Bob Farrell, one of the all time great market analysts was quoted in Barron’s saying, “When all the experts agree, something else is going to happen.”

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