Are We in Normal or Historic Times? - Weekly Blog # 957

 

 

 

Mike Lipper’s Monday Morning Musings

 

Are We in Normal or Historic Times?

 

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

            

 

 

The Single Most Critical Job

In thinking about the investment future, the critical job is guessing what the near future will be like compared to the past. Is the next period going to be like the last five or ten years, or possibly the downfall of the leading country of the world?

 

In trying to ponder ways of thinking about the future, it starts with an admission that I don’t know what the investment future will be. The second admission is acknowledging that I do not know what global changes will occur that have not existed in the world. For example, the discovery of the new world, the harnessing of electricity, and developments in the medical world. However, a study of human history and some understanding of geology can be useful.

 

Everyone has their own way of thinking about relevant financial behavior, whose models often parallel most others. I have devoted an adult lifetime to the analysis of the investment performance of mutual funds, with emphasis on those offered for sale in the US. These funds were used by a large portion of the American investment public and were something of a model for investors from other countries.

 

The US Experience

The largest portion of mutual fund money is invested in 8,162 US Diversified Equity Funds, with total assets of $20.7 trillion dollars. This group excludes narrowly focused specialty equity funds, overseas funds, fixed income funds, and commodities funds. Over the last five and ten years through last Thursday, the average investment performance including reinvested capital distributions was a gain of +8.26% and +11.09% respectively. These periods included relatively mild recessions and no depressions or global wars. Looking at longer periods, these results were better than average.

 

These results repeated over long periods have met the retirement needs of individuals and institutions for capital investments. They delivered good results which hopefully will continue, although I doubt it.

 

Historical Long-Term Lessons

President Trump will soon meet with Chairman Xi again. The last time they met Xi asked, “Can China and the US overcome the Thucydides trap expressed by the ancient historian and general Thucydides?” The Thucydides trap is the point at which financial and military costs exceed the productive capacity of the domestic economy, which is what led to the fall of the richer Athens over Sparta.

 

Is the US Approaching the Trap?

The Federal debt has reached $40 Trillion, with two war efforts by the US. This weekend Russia recognized its problem by entertaining into high level negotiations with US officials to resolve some unclear proposals for peace in their war with Ukraine. Both Russia and China are supporting this expensive battle, as is the US.

 

The current US debt expansion is causing European and other countries to reduce their ownership of US dollars. This weekend, Norway is reducing its holding of dollars by $17 billion. The dollar is slowly losing value relative to UK Pound Sterling and the Euro. In addition, private US debt is increasing through private debt channels. (When retail investors are enticed to buy investments that are new to them, it has not led to an extended period of gains.)

 

Investment Advice

While there are some positive signs, it would be wise to be careful. An important size buying reserve could be useful.

 

 

 

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Mike Lipper's Blog: Is the Volatility of Data in Hiding? - Weekly Blog # 956

Mike Lipper's Blog: Fears On a Quiet Summer Weekend - Weekly Blog # 955

Mike Lipper's Blog: What Could Go Wrong? - Weekly Blog # 954

 

 

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This Weekend’s Learning Sources - Weekly Blog # 939

 

 

 

Mike Lipper’s Monday Morning Musings

 

This Weekend’s Learning Sources

 

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

 

          

 

Identifying sources of learning

One of the main differences between us and most animals is that our brains are larger, which hopefully means we can learn more. The end of this week supplied three sources of learning. The three teams of instructors were: Tim Cook (Steve Jobs), Berkshire Hathaway’s Annual Meeting with shareholders (Warren Buffett/Charlie Munger and Greg Able), and the Bettors and Horses at the Kentucky Derby. From each I can learn a lot. Matter of fact, each could be a whole semester at Business Schools instead of what they are currently teaching.

 

Tim Cook (Steve Jobs)

At the end of the so-called work week Tim Cook conducted what was his last quarterly meeting for shareholders and analysts of Apple (*). He focused on the company’s critical relationships with customers and what is owed to them. He stressed what Steve Jobs taught, the betterment of the users’ lives. These were the critical thoughts passed onto the oncoming new President of Apple. We should pass these views onto all we deal with, focusing less on what they paid us and more on what we did for them.

* Owned in personal and client accounts.

 

Warren Buffett/ Charlie Munger & Greg Able

Mr. Buffett spoke to many of the shareholders attending the annual Berkshire Hathaway (*) meeting, both in person and electronically. His advice for people reaching 50 years or older was to switch their primary investment focus from making money to capital preservation. He emphasized saying no, particularly to not well understood new investments. (I do not own any “AI” stocks directly, but there are many in mutual funds I own. The key to their future is what they have yet to produce, not what they are selling today.) He believes investors in retirement should prune their holdings and try to explain what they own to their heirs, feeling it is more beneficial to focus on how the inheritance should be used rather than the intricacies of what is owned.

* Owned in personal and client accounts.

 

Greg Able is the new President of the company and is focused on improving the operations of the company. When the talented Chief Financial Officer transitions into retirement, he will be replaced with both a CFO and a new lawyer. Furthermore, for the 31 private companies owned by Berkshire, he has appointed a trusted internal executive as leader. Instead of doing just financial oversight, he will be reviewing the operations of the formerly private companies. Good policies of the past will be reviewed to see if they are right for now.

 

My personal view is that there are two major trends which we did not have to deal with in the past, but which could be much more important in the future. The first is one of the causes of financial and economic cyclicality resulting from not repaying debt on time and at full value. Defaults on debt have led to depressions in the past and have been the cause of unplanned contractions.

 

In the decade of the 1920s into the early 1930s society encouraged the global extension of debt at the retail level, including its use as a defense against tariffs (Smoot Hawley).  Currently, we have an expanded federal debt led by someone who needed to renegotiate his own debt. Our government encourages investing retirement capital in debt. The national debt is larger than the GNP. (Old debt has a due date, while GNP is produced each year.)

 

The second dangerous trend is the value of the dollar in world trade. As debt grows, overseas investors value it less. Meaning, it not only becomes more expensive for funding our debt, but also for paying for imports of food, clothing, and raw materials. We are better positioned than many other countries who are in worst shape, but not all. Asia, which has a younger population and a disciplined workforce, is in better shape. Higher inflation leads to lower long-term value of the currency. One measure of inflation not issued by our overworked government is the ECRI Index of Industrial Prices, which was up 140.35% this week for the last 52 weeks.  

 

Kentucky Derby

I brought this on myself by stating that I learned the basic tenants of analysis at the New York Racetracks. A subscriber asked who I was betting on in the race. Where do I begin? Perhaps with two axioms. First, as with most things in life, short answers are often wrong. The short answers are wrong because they are stated without limits and conditions. That brings us to the second axiom, I don’t like losing. I don’t like losing because it is a double loss. The first loss is the sum wagered, and the second is the loss of funds necessary for future betting and other things.

 

There are two negatives against betting at the track. First, the track takes a cut of all bets and there are personal expenses of travel, admissions, and food. Second, as a game of chance it is rigged because of the track’s take. Additionally, winnings are taxable at federal and state levels. There is still another drawback, about 30% to 50% of the time the lowest yielding horse wins. Most of the time those winnings are not large enough to offset losses and expenses incurred. I address this problem by limiting the number of times I bet, usually 3 out of 9 races and rarely at the lowest odds. The advantage of this approach is staying away from betting at the lowest odds, which are the most popular horses.

 

If these issues did not cause you to find other things to bet on, the elements of the Derby might. First, the race is only for three-year-old horses. While horses are born for the record throughout the year, under racing law all horses are born on January 1st. Some horses start their racing history at 2 years old, but many do not. By the time they are three years old they are adolescent. (From a scientific standpoint it would be useful to know the actual date of birth. There is poor but available information as to the number of official races the horse has run. In terms of the Derby, the range I heard was 1 to 4 races.) For those of my age, I am reluctant to take adolescent horses and most humans seriously.

 

So, after all this I did not place a bet on this year’s Derby. Most of the time I am not interested in races for three-year olds that are run any earlier than June, which starts with the Belmont Stakes race. These races are also a bit suspect because the course has been altered.

 

I would not have bet on the winner this year. However, the trainer deserves to be congratulated as she was the first woman trainer to win the Derby. The night before she had a dam which won the Kentucky Oaks with the same jockey who won the Kentucky Derby. Quite an accomplishment.

 

All of this shows I am still a student and hope you are as well.

                                        

 

 

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Mike Lipper's Blog: Watch Out for the Four - Weekly Blog # 938

Mike Lipper's Blog: Investors’ Interlude - Weekly Blog # 937

Mike Lipper's Blog: Not Yet Ready for a long-term Solution - Weekly Blog # 936

 

 

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Investors’ Interlude - Weekly Blog # 937

 

 

 

Mike Lipper’s Monday Morning Musings

 

Investors’ Interlude

 

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

 

 

 

Take Some Gains Before Taxes Do

The common denominator for most big investment gains are changes. Usually changes in investor perceptions and economic structural changes. The Standard & Poor’s 500 (S&P 500) and NASDAQ Composite are at record highs, due largely to enthusiasm for announcements related to the suspension of fighting in the Middle East. (This is not true for the Dow Jones Industrial Average (DJIA) and the average stock.  Unfortunately, since WWII the US has had a history of winning wars but losing the peace.)

 

We do not know the total cost of the war and other spending, including election-oriented payments. I suspect the President’s desire for a lower valued dollar will be achieved. There is also a strong push from urban legislators for “fair taxes”, also known as “tax the rich”. Thus, I believe capital gains rates and estate tax rates will rise.

 

Due to these expected changes long-term investors should review their portfolios to see how much of their wealth should be realized before their estates are taxed. If this generates significant amounts of cash, I suggest maintaining the cash or short-term treasury holdings for reinvestment.

 

I believe there will be positive changes in the foreseeable future. These changes may be driven by technology, demographics, immigration, and global factors. These changes are likely to be net larger than politically motivated changes and you want to be in position to take advantage of them.

 

Investment Impacts of Past Changes

The Founding Fathers were afraid of the powers of government, so they placed our Capitol in the humid swamp of Washington DC, thinking our legislators would desert the “swamp” during the humid months. That worked reasonably well until the development of air conditioning. The end of the government’s year is now September 30th, after the summer political conventions, which reduces the time for debating many of the critical issues of the day. DC is now a year-round city for government workers and legislators. Many work or live in large buildings constructed and possibly owned by real estate families who are probably wealthier than the US Senate members. Thus, the advent of air conditioning changed how our government works.

 

Another unexpected change was the railroad growth of the late nineteenth century. The highly regulated railroads only made profits on freight travel and lost so much money on human passengers that the federal government became the principal owner of passenger travel. The freight lines are governed by both the Department of the Interior and Anti-Trust laws. This has led to other countries having better and cheaper train service than we do, paid for by charges on the goods we consume. It is interesting to note that the Dow Jones Transportation Index, which covers the rails, was the best performing market index this past week. The rails are still important.

 

Future Changes

We live in an environment of an increasing rate of change. I leave to others to identify the changes which most investors would not be surprised by.

 

Geographic Changes

1. Western Hemisphere countries have become more partners than adversaries in terms of trade, health practice, external and internal defense, probably led by Canada.
2. Russia, after Putin, will experience major political and economic changes.
3. Asian countries that border both Russia and China will come into their own in terms of trade and be more open to development.
4. African countries will welcome joint development from Western countries.
5. Indonesia and India will become less autocratic, with foreign companies able to generate substantial sales and earnings.
6. Each country will make their own rules.

 

Retirement Issues

1. Over time, US Social Security will be allowed to exclude US government paper and possibly approach being a foreign wealth fund.
2. It is reasonable to expect that those born recently will live to at least one hundred, so we will need to provide for longer periods of investment and spending.
3. For the same reason, private retirement vehicles will need to change.

 

Market Regulation

1. Using the last trade may no longer be appropriate if it is too small and unrepresentative of the size of the seller.
2. As more stocks and possibly bonds trade in size in after-hours, having a closing price on the exchange market may be unrealistic.
3. From a technology perspective, there should be a body that can approve of their use for retirement accounts.
4. Should issuers of a certain size be required to have assets or insurance on the life of the CEO that can be used in retirement accounts.

 

As usual, I would love our subscribers to share their views with me. 

                                        

 

 

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Mike Lipper's Blog: Not Yet Ready for a long-term Solution - Weekly Blog # 936

Mike Lipper's Blog: We Have a Management Problem - Weekly Blog # 935

Mike Lipper's Blog: Is History Rhyming Again? - Weekly Blog # 934

 

 

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“Hide & Seek” - Weekly Blog # 880

 

 

Mike Lipper’s Monday Morning Musings

 

“Hide & Seek”

 

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

 

                             

 

Friday’s Victory Signal?

After an extended period of stock price declines, prices shot up on Friday. The “Bulls” hoped it was the beginnings of a “V” shaped recovery, but some market analysts were skeptical. A strong move often ends when there is a 10 to 1 ratio between buyers and sellers, which was the case with Friday’s 10 to 1 ratio.

 

The Wall Street Journal publishes “Track the Markets: Winners and Losers” in their weekend edition. It tracks the moves of 72 index, currency, commodities, and ETFs weekly. It may be worth noting that only 35% rose for the week.

 

The Second Focus

The media, and therefore most of the public focus on daily price changes. Even with the growth of trading-oriented hedge funds and the conversion of former securities salespeople into fee-paid wealth managers, the portion of the assets invested in trading is less than the more sedate investment accounts invested long-term for retirement and similar institutional accounts. My focus is on the second type, which includes wealthy individuals.

 

The Current Administration is Ignoring Us

The first step in security analysis courses often starts with reading what the government puts out in order to develop a foundation for an investment policy. The current administration is the most transactional in memory. The President, Vice President, and Sectaries of Treasury and Commerce made and lost money on market price changes. This has forced me to find other sources to build our long-term investment philosophy.

 

Inevitable Recessions

Studying both recorded history and our own lives, it tells us that life does not move in straight lines, but in cycles of irregular frequencies and amplitudes. Simplistically, we can divide these movements into good and bad periods. However, an examination of the periods reveals differences in how each period affects us. The differences and how they affect us depends on where we begin each cycle, the magnitude and shape of the cycle, and any surprises along the way.

 

Both up and down cycles are caused by imbalances within their structures, which often occur due to other imbalances known or unknown. Most importantly, any study of cycles indicates they happen periodically and surprise most participants. Even with detailed histories of cycles they can be difficult to predict, although the root cause of most cycles is extreme human behavior.

 

While some cycles are caused by natural weather-related events, most economic cycles are caused by envy and/or too much debt. I am perfectly comfortable predicting a recession will hit us, but don’t know for sure when it will occur. (In a recent discussion with a small group of senior and/or semi-retired analysts, they felt there was a 65% chance of a recession within 12 months.)

 

The fundamental cause of cycles is often the result of people reaching for a better standard of living through excessive use of debt, which often results in a struggle to repay debt and interest. At some point the growing federal deficit, combined with growing consumer debt, as evidenced by credit card delinquencies, will force a decline in spending. Reduced spending will lower GDP and production. The fact or rumor of this happening is enough to bring securities prices down.

 

Confusing Hide and Seek

Hiding is not the solution to avoiding a loss of purchasing power, both actual and supposed. Cash is the only true defense, although it is not a defense against inflation which reduces the purchasing power of most assets. However, the biggest long-term loss from hiding is foregoing future potential high returns.

 

Our Approach

I believe a cash level no larger than one year’s essential spending should cover the crisis bottom. Most of the remaining capital should be devoted to seeking out substantial total returns that can produce multi-year gains.

 

Where are these Gems?

Bargains are usually hidden in plain sight. One example might have been the fourth quarter 2024 purchase of European equities, which were priced for a European recession. However, European equities actually generated expanded earnings from Southeast Asia, Latin America, and Africa. (In a recent discussion with one of the largest investment advisers negative on investing in Europe. Their views were based on their continent’s own economics, while paying insufficient attention to companies growing profitably in the aforementioned regions)

 

Thus far in the first quarter I have been lucky enough to own both SEC registered mutual funds and European-based global issuers. (It took patience because earlier performance periods were not good.) This shows the need to be courageous when seeking future bargains. 

 

We would appreciate learning your views.

 

 

 

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Mike Lipper's Blog: Separating: Present, Renewals, & Fulfilment - Weekly Blog # 879

Mike Lipper's Blog: Reality is Different than Economic/Financial Models - Weekly Blog # 878

Mike Lipper's Blog: Four Lessons Discussed - Weekly Blog # 877

 

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Separating: Present, Renewals, & Fulfilment - Weekly Blog # 879

 

 

 

Mike Lipper’s Monday Morning Musings

 

Separating: Present, Renewals, & Fulfilment

 

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

 

 

 

 First Priority

Determining the motivation of the client and the account’s heirs is key to understanding the performance of most investment accounts. When asking the real investment account decision-maker about the driving motivation, it is often singular even though multiple other motivations are listed. (It often takes many discussions to reach the effective truth. Over time and changing situations the driving motivations may change.)

 

With most individuals, critical decisions are based on selected discussions with highly respected individuals, which may change over time due to changing circumstances. Most often these individual decision advisers are not revealed to the “hired hands” of the portfolio manager. All too often the unofficial managers express their opinions based on their own experience, which may have little relevance to the long-term needs of the account. These accounts are effectively managed by people known and unknown to the professional manager. Thus, the crucial job for the professional is to communicate effectively with those having meaningful influence on the account. Not an easy job.

 

The Second Motivation

The owner of the account should understand that there is a second motivation operating in practically all situations. The prime motivation of the investment manager is to continue the relationship with the present controller of the account, which includes the periodic renewal of the relationship. The relationship rests primarily on the communication skills of the manager in reaching the expected satisfaction level. This is a two-part job, where the first task is setting and updating expectations. The second task is delivering the expected return and communicating the proper expectation. This is again a two-fold job, with the first task satisfying the adjusted needs of the account in absolute return terms. The next part is where many managers fall down, the artform of selecting appropriate comparisons. This is where my biases enter. I do not believe a managed account should be compared to a list of securities selected by a manager. It should instead be compared to a fund portfolio with real expenses and diversification requirements, similar to the account itself.

 

The Most Important Motivation

Most of the money in the United States is managed directly or indirectly for “retirement needs”, which has lengthened over time. “Retirement” can include the institutional needs of academic, medical, and cultural institutions. What makes these accounts challenging is the receipt of money near term to meet future needs, which may not be well-defined in the current period.

 

Currently, the biggest hurdle in managing long-term money is the new economic/financial situation, which is different from the recent past. Most of the time change moves relatively slowly, which allows the participants time to adjust their actions to the pace of change. However, there are some brief periods of even more rapid change where it is difficult to catch up and adjust to the radical changes. I believe we have entered such a period and expect to have more difficulty predicting the future. For a period, we will likely be out of step with the fundamental changes likely to occur.

 

What is Changing?

The following elements of change surfaced last week.

• Weekly S&P sector performance: S&P Finance +2.80% vs -4.01% for S&P Tech.
• Goldman Sachs will soon cut 3-5% of its Vice Presidents.
• Schroders will lay off 200 employees to refocus and improve profit margins. They will also cut their Executive Committee by half, which is 44% family owned.
• There are $3 trillion ageing and unsold private equity deals. (Retail investors are taking risks in Private Equity that exceed public investing protections.)
• The US has not seen so much restructuring in the Federal Government, Corporations, Energy, and Retail since the Depression.
• The AAII weekly sample survey’s 6-month bullish prediction is now 19.3% vs 57.3%. (The lowest I have seen, which is often wrong at turning points)
• Global financial communities are developing new instruments that can be leveraged.
• With copper and coffee commodity prices going up, I am not surprised the Fed is holding off on lowering interest rates.
• There is probably more to the reluctance in naming a bank supervisor than we know.

 

We know that history does not repeat (exactly), but it does rhyme. There is an incomplete comparison one could make with the 1930s, but I hope it isn’t so.

 

 

 

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Mike Lipper's Blog: Reality is Different than Economic/Financial Models - Weekly Blog # 878

Mike Lipper's Blog: Four Lessons Discussed - Weekly Blog # 877

Mike Lipper's Blog: Recognizing Change as it Happens - Weekly Blog # 876

 

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Sentiment Appears to be Changing - Weekly Blog # 689

 

Mike Lipper’s Monday Morning Musings

Sentiment Appears to be Changing

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

Where are We?

In theory, securities markets discount “the future”. We are comfortable believing we “know” where we are going, which is a useful charade because we really don’t know, partially because we don’t know where we currently are. We are bombarded with up to the nanosecond prices, which only tell us about transactions occurring for unknown or appreciated reasons. Far too many investors give convenient reasons for price moves without looking at the underlying data. For example:

• In this past four-day week, down day share volume was higher than up-day share volume. There are three possible reasons for this:

1. With light overall volume, normal liquidations counted for more.

2. Lower prices brought “buy the dip” traders in.

3. Possible recognition the next 12 months wont produce from the bottom type gains.

• The industrial price index tracked each week declined a bit, suggesting the intensity of the inflationary drive is lessening. 

• Performance leadership was too diverse. For June, the 3 best mutual fund peer groups were Natural Resources +13.5%, Latin America +12.4%, and Real Estate +11.3%. (We can discuss off-line with subscribers.)

There was however a performance change that generated a lot of comments by pundits, as well as a few calls to me seeking an explanation for the good June Large-Cap Growth Funds performance of+5.63%, way above the Small-Cap Growth Funds return of +3.68% and the Large-Cap Value Fund return of -0.99%. Large-Cap Value funds beat Large-Cap Growth Funds in the first quarter with returns of +11.05% and +1.57%, respectively. 

On average, stocks in “value” funds have materially lower price/earnings ratios than “growth” funds. The justification for the higher growth fund p/e is that they produce higher earnings. However, they also appear to be more predictable, allowing investors to believe they can extrapolate those earnings for a longer time. Many “value” funds have significant cyclical characteristics and economic cycles are typically of shorter duration than the perceived length of growth. Thus, one interpretation of the switch back to growth leadership is the cyclical peaking of economics favoring value in the second quarter, which will probably contract in future periods.

Outlooks

Remembering my absolute right to be wrong, I searched for clues to the unknown future in 3 buckets: economic data, structure of the American securities markets, and policy pronouncements. From my standpoint it is not important you believe these views and perhaps act on them, but it is important you are aware of them in forming your own views. There is some chance I may be correct, at least in part.

Economic Data Points

Most of the US and much of the Developed World are emerging from the “lockdown” phase with the realization that aggregate financial wealth has grown through the price appreciation of homes and marketable securities. (It is too early to know the size of the expected loses and hopefully lessons learned by new investors.) What is known from recent government statistics is housing costs have risen to over 30% as a percentage of income. Some of the increase is perhaps offset by a temporary reduction in commuting and office clothing costs. In the past, housing and commuting costs were expected to be below 25% of income. The diverted income probably came from the portion not going into investments, which was intended to be used for debt repayment,  retirement, and schooling costs. Because of the appreciation in the cost to buy a home, renting has become more popular. The problem is that there is no opportunity for capital growth, so there’s a good chance that investing for retirement will lessen and the age of retirement will lengthen.

Much is being written about the inevitable risk of rising inflation. Although most of the focus is a future number, the danger from rising inflation is how it will influence the spending habits of individuals. In looking at major future expenditures, people will either accelerate purchases to avoid future price rises, delay purchases until prices drop, or wont purchase the products or services. All choices will be somewhat negative for long-term economic growth. The key to inflation expectations are whether they extrapolate present levels or anticipate a material change in the rate of inflation. Recent surveys of inflation expectations broken down by the age of the predictor are insightful.

Inflation Expectations

Age Group  Expectation  Contribution to Economy

Under 40       3.2%           Net Spenders

40-60          4.0%           Net Savers

60+            4.6%           De accumulators

If there are not habit changes and the absence of negative changes, these projections could be low. (In the past, savings did not accelerate unless savers received at least 2% above inflation, or a minimum of 4%. The gates my not open widely below 5%.)

Market Structure

While the US’s share of global GDP is 16%, our share of global market capital is 44%. While there is some logic that US GDP will grow in absolute terms, its share of market capital is likely to decline. One reason is that we have made being a public company unattractive. The 2000 largest public companies listed by Russell shows 499 being growth stocks and 842 being value stocks. MSCI can only find 434 European companies to track and 1547 companies in the Asia Pacific. To provide the necessary retirement income, US and European investors must invest beyond their borders and probably beyond their governments.

Even during a week where growth outshone value, investors in NASDAQ stocks were far less bullish than those on the New York Stock Exchange, measured by the ratio of new highs to new lows: 

         New Highs vs New Lows

NYSE           380 vs 90

NASDAQ         287 vs 220

Policies

 Almost always it is risky to take politicians’ words at face value, they show what the public wants to hear but not their real intent. With the current administration we have some pretty good clues as to their model. One unmistakable clue is the return of the Franklin Delano Roosevelt bust to the oval office. The stated goals of the current tenant are close to a carbon copy of FDR’s second term, which needed WWII to bail the country out from its socialist policies.

I can email the “Executive Order on Promoting Competition in the American Economy” (29 pages, plus 48 pages of a fact sheet) if anyone cares to see it. One should understand that these documents are written by lawyers with little or no business and/or investment experience. 

Working Conclusion

We have entered a new phase that is unlikely to benefit from the strong tail winds that peaked in the second quarter. For those that are prudent, there are signs of potential stock and economic trouble ahead. As with the study of what causes wars, there are both underlying and immediate causes. In terms of the battle for investment survival, there are cracks in the foundation of the investment structure. (This is not an intended reference to the collapsed 40-year-old condo.)  There is not yet a visible immediate cause for a meaningful decline. (Assassination of the Crown Prince, the immediate cause for troop movement in World War I.) Consequently, prudent investors should adopt a trading approach for their short-term oriented funds and be prepared to increase their long-term positions at lower prices.

       

        

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

https://mikelipper.blogspot.com/2021/07/independence-day-3-investor-lenses.html

https://mikelipper.blogspot.com/2021/06/what-did-fridays-market-political.html

https://mikelipper.blogspot.com/2021/06/mike-lippers-monday-morning-musings-50.html

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Observations: “You can see a lot just by observing” Yogi Berra - Weekly Blog # 679

 

Mike Lipper’s Monday Morning Musings

Observations:

“You can see a lot just by observing” Yogi Berra

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

                          

Investors Should Learn by Observing Others

The art of investing is based on observing elements that others do not see or interpret. One example is a comment from a young person about investing. She asked, isn’t the most distressing investment Bitcoin? I saw this as a learning moment and replied that the most distressing investment is cash.

Except at the very beginning of an individual’s investment career, cash should never be the predominate asset in their portfolio. However, cash whether people know it or not, sits at the very center of the concentric circles that make-up an investor’s portfolio. Even when one buys or sells an investment, it momentarily passes through a cash phase. A more important point however is that when an investor contemplates their entire portfolio, they do so in terms of its cash value. Furthermore, the level of cash serves as a rough guide for the current confidence in the remaining holdings, which should include perceived liabilities.

Most investors prefer to combine their investments into a single documented portfolio. This minimizes the time and emotion of comparing current assets with future needs and desires. Just as I don’t have only a single hammer in my tool kit, I also don’t believe in a single investment view or portfolio.

Managing and Measuring

You can’t cope well with problems/benefits or assets/liabilities you can’t measure. Every element of our lives cannot and should not be measured to the fifth decimal place. Initially, the most important decisions are binary, good or bad. Only later can you attempt to analyze how good is good or how bad is bad. Some portion of  concerns may revert to using cash as an imperfect measuring tool. 

At this point in the development of my thinking I find it useful to divide tasks into segments, assigning problems/benefits and asset/liabilities to separate portfolios, usually based on when cash will be needed to pay for the desired result. This segmentation allows me to assign different assets to different problems, potentially suggesting the use of different assets and investment strategies.

Regardless of whether you maintain a single portfolio or multiple portfolios, you need a framework to decide whether you are accomplishing your goals, moving in the right direction or need a mid-course correction. In the next section I briefly suggest the elements to use in building a portfolio measurement approach.

Framing the Measurement   

Critical end dates and periods to measure and analyze choices:

12/31/21

11/10/22 (For US Taxpayers)

12/31/31

Retirement

Estate

Multi-Generation

Most important decision centers:

Capitol Cities – Washington, London, Beijing

Capital Cities – New York, London, Shanghai

Size of loss tolerance 

10%

25%

50%

100%

Cost (for long-term holdings)

Investment Policy or Critical Personnel Changes

What Yogi Might Observe Today

1. This week, the normally more speculative NASDAQ market is less “bullish” than the larger cap NYSE market in terms of the percent   of traded issues reaching new highs, 11.8% for the NASDAQ and 22.7% for the NYSE. Short position changes last month had the NASDAQ increasing +2% and the NYSE +1%. 
2. International Markets performed better than US: Taiwan (+19.5%) was the best performer, followed by South Africa, Canada, Singapore, France, and Hong Kong. The US followed Hong Kong with performance of +11.4%. South Africa and Canada are metals and energy driven.
3. T. Rowe Price’s target date funds reduced their commitment to US stocks due to lower expectations.
4. Robert Kaplan of the Dallas Fed thinks the Fed should recognize increased speculation by considering an increase in rates.
5. Some believe the real reason for increases in government spending is to increase the deficit, in order to raise taxes on the “wealthy.”
6. Hunter Lewis, developer of the “endowment” model at Cambridge Associates, believes it is outmoded since most academic endowments and  pension funds  use it and rely on important allocations of private equity and real estate.
7. Warren Buffett at the Berkshire Hathaway (*) annual meeting noted two things of general value: 
1. None of the 30 largest stocks by market capitalization from 30 years ago are on the list today.
2. Reports from their 60 plus affiliates indicate inflation in their costs.  
• (*) Owned in Private financial Services Fund and Personal accounts.
8. Medina Spirit led all the way to win The Kentucky Derby. The colt was purchased for $1,000 and was the 6th most favored horse in the race. It was Bob Baffert’s 7th Derby winner.

My interpretation of these observations is to be careful with short-term oriented accounts.

What do you think?

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

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

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

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

The Wisdom of 3 Wise Men - Weekly Blog # 663

 

Mike Lipper’s Monday Morning Musings

The Wisdom of 3 Wise Men

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

                   

Those who spend a great deal of time, energy, and emotion investing are truly “career” investors, whether they do it for a fee as a professional agent or as a personal investor. The successful ones focus on areas beyond security selection, including policy decisions. They are scouts leading away from capital destruction and toward capital appreciation. To do this, their natural position in the march of time is to be way ahead of the parade of followers of current trends. Successful investors are often lonely, fearful of falling into an avoidable trap, often searching for clues that others have found.

US investors will suffer a new government beginning in ten days, made up mostly of career politicians who participate in a former government producing slow, uncertain growth and loss of relative strategic power. Asia, particularly China and to a lesser degree India, plus the Middle East and Africa, represent challenges and opportunities likely to drive higher investment returns relative to those in Continental Europe. Under these circumstances, as a contrarian, I am paying attention to three investment wise men.

Jason Zweig wrote in this Weekend WSJ, “In theory investing is all about markets: in practice it is more about marketing.” Jason was addressing the old tale that stocks and funds are not bought but are sold, largely based on the marketing of past performance. The easy approach for salespeople and others is to extrapolate the immediate past. In the commodities markets, which often exhibits long trends, there is the motto “the trend is your friend”. My study of sports, economies, politics, and markets is that all trends either end disrupted or exhausted. The longer the trend, the more competitive forces will seek to replace the presumed longevity of the trend.

Jeremy Grantham of GMO points to the career risks of being too premature about future drastic changes in direction. He was admittedly three years early before the Japanese market topped out. In another instant, he lost half his clients in one strategy by being premature. The lesson here is to gradually withdraw and add to various sectors or philosophies. While it may be emotionally satisfying to go “all in” or “all out”, it is extremely arrogant in terms of career risk. We should also remember that the prime function of markets is to create humility. We can be wrong.

Benjamin Graham has been called the Father of Security Analysis and was a successful fund manager with both wins and losses. He said “Never mingle your speculative and investment operations in the same account, nor in any part of your thinking”. I don’t remember when I came up with the idea of creating sub portfolios for different purposes, but earlier he was focusing on different approaches for different investment purposes. At the racetrack it is called “different horses for different courses”. 

I often advocate sub-portfolios for different time periods to meet spending needs. As the weakest securities disappear in terms of impact over time, the longer a portfolio functions the greater the odds of success. Almost all the accounts we have held for twenty years or more are profitable. Under today’s conditions of increased uncertainty, I wonder whether two new sub portfolios should be set up. 

• The first would have a four-year duration based on the probability that much of what the incoming administration accomplishes will be reversed by a new administration in 2024. I am particularly focused on tax rates and regulations. 
• The second trading portfolio would have a one-year focus based on the effective timing of new legislation and executive order implementation. It would trade on the rumors of the progress of various political actions. 

Despite the financial media focus, the bulk of equity investments are long-term, both for retirement and estate building purposes. We have just finished an above average ten-year period where US Diversified Equity Mutual funds averaged an annual gain of +12.69%, with the median fund rising +11.71%. To do better than these results one needed to be invested in growth-oriented funds, which were more volatile than other stock portfolio peer groups. I have doubts that the next ten years will be as good as those in the past. Considering my outlook for interest rates, inflation, the value of the dollar, demographics, and technology, performance of no more than half the level of the last ten years might be viewed as heroic. One might even predict a lower return. (Interestingly, if we did experience a low ten-year growth rate, the following ten-year rate would probably be much higher.)

Current Updates

• For the first week of 2021, the average S&P 500 Index fund gained +1.30% vs +2.59% for the average US Diversified Equity fund, continuing the pattern of underperformance delivered in the last half of 2020.
• The AAII weekly sample survey of its members’ views for the next six months is 54% bullish and 26.6% bearish. Market analysts treat this as a contrarian indicator. 
• An interesting mathematical insight is that these ratios are approximately 2 to 1. They are in the extreme range and I would not be surprised if they reversed, with the S&P Index funds doing better and the six-month trajectory of the market doing worse.
• The JOC-ECRI Industrial Price Index remains stubbornly high, generating a +26.6% gain year over year.
• Truck tonnage carried is moderating an early spike.
• The S&P 500 was up for the first five days of 2021 and more often than not that heralds a positive year. The full month of January is a stronger predictor.

Critical Question:

Do you regularly examine your investment policies or is most of your attention spent on security selection?

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

https://mikelipper.blogspot.com/2021/01/anticipating-topping-us-stock-market.html

https://mikelipper.blogspot.com/2020/12/stud-poker-new-swamp-game-weekly-blog.html

https://mikelipper.blogspot.com/2020/12/mike-lippers-monday-morning-musings.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

                   

Default Discussions Could be Good for Sound Investing

A few years ago there was a not too successful Broadway play with the title “I Love You, You’re Perfect, Now Change.” That is the way I am beginning to feel about the endless discussion about a possible default by the US government if it cannot borrow new money as of August 2nd.

First, let me say the obvious, that I do not know what political solution will accommodate the opposing forces of spending too much money and the unwillingness to pay for it. Having seen the professional negotiators for my clients (the National Football League and the former NFL Players Association) apparently come to agreement after a four month lock-out, I have great faith that some interim agreement is probable. Like with the football agreement, for those of us who care, God will be in the details. While both disagreements were foreseeable for at least the last two years, the players in Congress and the White House have not been in serious negotiations until perhaps a month ago, thus they lag the professional negotiators for the football collective bargaining agreement.

Second, the financial community has been of two minds, either there will or will not be a default. Separating all the chatter from market prices has a way of sharpening the focus. One of the more modern innovations to the bond market is the development of credit default swaps (CDS), in which the buyer wants to be assured that he/she will receive full payment of principal and interest when due, and the seller will insure that delivery. CDSs were initially used for high yield bonds (junk bonds), more recently a market has appeared for those who want insurance on sovereign debt of various countries. One of the ways the market gauges the chance of a downgrade is to rank the cost of CDSs on $10 million face value bonds. According to Saturday’s Wall Street Journal, “Currently, one-year protection against a U.S. default is roughly double that of other triple-A rated nations such as the U.K. and Germany….” The article also states that the cost is higher than for Indonesia with a credit rating of BB+. According to Markit, the cost for the 1-year CDSs and the annual five year cost is an identical 53,000 Euros or approximately $76,000. Further, the WSJ article states, “The annual cost of protection over five years, which more investors focus on, was also €53,000, but has risen by a smaller magnitude since January 2011 and remains well below its peak of €100,000 in early March 2009, at the height of the recent financial crisis.” These are small markets and do not represent the market judgments of hundreds of billions of dollars held by various institutions around the world. If that is not enough of a warning, I have been informed that the six leading insurance companies with an AAA rating may be facing an immediate down-grade because so much of their required reserves are held in US government paper.

Third, while up to this weekend the markets have not significantly reacted to the possibility of a failure to raise the debt limit, some have been thinking quietly about how to operate under such conditions. For example, I believe that there has been a group within the Federal Reserve developing plans as to what checks will be honored and when. I know that a number of government contractors including Caltech, which I have the privilege to serve as a trustee, have drawn up plans to deal with an uncertain stream of payments. If by the opening of markets on Monday there are others accelerating their contingency plans, interest rates will rise and fixed income prices will fall.

Fourth, the much maligned, but essential credit rating agencies’ warnings of a downgrade will be examined more closely. (Our financial services hedge fund has a position in Moody’s.) Unlike most other downgrades which are based on the odds that there is some insufficiency to meet debt obligations, these potential downgrades are based on the evidence of an unwillingness to meet our obligations.

The Good

How can any of these traumas be good? First, the situation forces recognition of the inevitable clash between our society’s apparent demands for goods and services from the central government and our willingness to pay for them concurrently. Similar clashes are observable in numerous European countries that have had socialist leanings for a long time. This battle of wills was a long time coming and it was naïve to ignore the issues as the markets have largely done. Whatever the outcomes of these struggles, we are entering a true-up phase which recognizes that deficits do count and cannot go on forever. Second, few of us fully recognize the multiple roles the government plays in our lives. For example, one can not travel by air, rail, boat, or by road and not be subject to governmental rules and regulations as well as the spending of taxpayers’ money that subsidizes our movements. In similar fashion, in the fields of energy and health care, we have become heavily influenced by government actions and direct as well as indirect payments. Clearly among the most dependent arenas of government influence are the financial markets (bonds, stocks, commodities, real estate and intellectual properties). Most often prices in these markets are directly or indirectly priced off of similar maturity Treasuries. The private sector’s retirement contributions are keyed off of the level of interest rates for many pension plans and the investment policies stated or unstated for defined contribution and other retirement plans. Note that in periods of turmoil, various investment policy statements and prospectuses permit a 100% commitment to Treasuries.

Why do I say that listing these dependencies on potentially downgraded government paper is good? The first step in helping a person with some form of behavior disorder is to recognize the problem and the levels of chemical or other dependencies on the source of the problem. Without this recognition, there will be little chance of a cure. I do not know what will be the various solutions used. But the genius of the American culture (also found elsewhere) is that we will find appropriate, if not elegant, solutions.

Better

If that is what I label as good, can you stand what I label “better”? Coming out of these economic traumas we normally look to change our risk exposure to past problems. The standard prescription would be diversifying beyond the all-powerful US dollar. That is going to be difficult to do. Almost all global assets have their prices impacted by US activities. Ideally we should look at public and private investments in countries that have relatively small populations but with sufficient internal capital to develop large resources for the benefit of the present and future generations of a striving population, e.g., Canada, Australia, Singapore and Mongolia. These were some of the main characteristics that have made the US an attractive place for both domestic and foreign investment in the past. We are on a search for the next investment horizon. We are not alone; many of the international portfolio managers that I speak with are on the same search either directly or through the companies that they put into their portfolios. Whether they recognize it or not, most institutional portfolios of endowments and mutual funds are also deep into the difficult process of finding different, and hopefully better places for investment.

The ultimate irony of both the debt/expense problems and the search for new investments is that it is possible, perhaps unlikely, that the American public will take its bitter medicine so that the children and grandchildren of the US will once again live in a society that is an attractive investment home. That truly would be best.

Do you have any long-term solutions or portfolio construction suggestions?

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