Collateral Rewards, Risks, & Opportunities - Weekly Blog # 828

 

      

Mike Lipper’s Monday Morning Musings

 

Collateral Rewards, Risks, & Opportunities

 

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

   

 

 

Motivations

The attempt to be successful and original is hard work, as being an originator seldom leads to investment success. Better results come from striving to be an early participant in an investment idea. Great individual analysts search for a single great idea, usually an idea that few if any recognize.

 

Somewhat later and perhaps deservedly less successful are those who are early recognizers of those with great investment ideas or themes. The second group are collateral players, including public and private pundits working to identify these opportunities.

 

At one point in my professional life, I was a candidate for the first group. I devoted some of my time as an analyst to visiting plants, doing walking tours of workspaces, and attending industry sales presentations or government conferences. In order to accomplish these tasks, I often commuted on the earliest and latest trains. In addition, I also read numerous trade journals, which I no longer do.

 

Today, my “remote” research consists of reading or watching business communications, visiting buyside managers and their analysts, and walking through shopping streets and malls. In effect, my first glance at new products and services is when they are introduced to the buying public, so I am going to be late in recognizing new trends. The only offset I have is my prior experience, having seen many things in the past which may have some bearing on present and possibly future trends.

 

What Are Most Missing

Much has changed in the sixty plus years I have been watching.

1. Disclosure rules have changed.
2. Corporate executives meet investors and analysts in tightly scripted conferences or small meetings.
3. The published data is largely statistical in nature and is focused on the immediate past. Much time is spent on complaints about government restrictions and disclosure requirements. Two examples are the focus on demographics and worker counts. (This is the same trap political pools fall into.) A much more expensive and insightful source of useful information is psychographics, rather the demographics. While two workers may have the exact same job classification, one might be solely concerned about wages and hours while the other seeks career opportunities well beyond the current paycheck.

 

Questions Need to be Asked?

• What are the implications for the four largest net free cash flow producing companies, which reported over $50 billion each? This suggests to me that risk-taking finance and technology companies will be central to funding the future and could be its beneficiaries.

Net Free

Cash Flow

$ Billion

Goldman Sachs           $143 

JP Morgan Chase           87

Apple                     85

Google                    69

• The American Association of Individual Investors (AAII) is often viewed as a contrary indicator at turning points and last week the indicator switched direction. Those with a bullish outlook rose to 30.4% from the prior week’s 23.4%, while those who felt bearish fell to 41.4% from 53.7%. (The size of the switch and timing is unusual.)

• Lessons from the past for possible use in the future? In the 1930s the US shrunk its defense strength below its WWI level, while restricting oil exports from American companies to Japan. It also refused to permit the offloading of a ship of European refugees. (These actions were taken by FDR, whose portrait is the most prominent in the current White House. It hangs in the room where the President meets with current world leaders and US politicians.) 

 

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The Declaration of Independence and Your Investments

Introspection is not one of the listed activities for usual July 4th celebrations though perhaps it should be, at least this year, in terms of your investments. Let’s start with the Declaration itself. The assertion of independence, among other elements, was to sever dependence on Great Britain with its laws and its world dominating Navy and Army. In the future these United States would be governed by our own laws and natural, perhaps God given, principles. In a much less dramatic way, the recent reactions to the global financial problems are similar to the yearning for freedom which was sweeping the world in the 18th century.

Changes going forward

There is a good chance that going forward the investment world will be as different as were the changes in the political world as a result of the first successful revolution to create a new country. In a small way the enactments of the “Dodd-Frank Wall Street Reform and Consumer Protection Act,” “Obamacare,” and the European and the Chinese austerity programs plus the investor reactions to these moves will change the investment world going forward in a similar way as did the American Revolution.

Two important aspects of the Declaration

There are two aspects of the Declaration of Independence which do not get enough attention. The first is the framers belief in “natural law.” They recognized the limitations of appropriate government authority. They looked primarily to our citizens to follow the recognized natural law of seeking the pursuit of happiness among other rights. Putting this natural law into perspective today, we need to recognize how people operate within markets not only for securities but also for a full array of goods and services. There will always be more and less popular items. The congregation of popularity can be handled in most markets. When popularity becomes extreme, the market structure will force a higher or lower price. As prices gyrate so does the temptation to take advantage of driven transactors. There are other natural laws, e.g. nine women can’t have a baby in one month.

The second aspect the Declaration I would like to emphasize is the 56 signers. They were all risk takers, not just 11 merchants but also the 24 lawyers or judges. They paid for taking the risk of rebelling against the most powerful nation in the world. Five of the signers were captured, tortured and killed as traitors. Twelve had their homes ransacked and burned. A number died destitute or bankrupt.

The important things to remember from our founding are that from the beginning we were risk takers and we would look to new laws. As a group we are used to unimaginable changes. (I believe this attitude should be incorporated in our portfolio thinking.)

Entitlements

However, the saga of the Declaration shows we are only willing to move ahead so far until proverbially, we kick the can down the road. In today’s terms, the issue that our Founders could not settle was an entitlement. We properly recognize it as slavery. For many it was a moral issue and for others an economic entitlement. With the coming austerity programs, I believe we are on a collision course with entitlements. Just as the issue of slavery in the US was settled with much loss of life in the Civil War (unlike the UK, where the issue was settled bloodlessly), I fear there will be high social costs to a cutback in entitlements. Some of these costs will be borne by investors.

Portfolio implications

With all of this as background, what should we do to prepare our portfolios for the post revolutionary phase? I would suggest the following as a general outline that needs to be adjusted for each investment account:

1. A large liquid tactical reserve.
   
2. Equities of companies that can adapt to change.
   
3. Investments in countries of savers who also have rising productivity.
   
4. I would avoid those “go anywhere” funds, not that the concept is faulty. The practice unfortunately is that these portfolio managers go back to the securities they are accustomed to. Very few of them learn new things.
   

Please share with me how you are preparing for the post regulatory revolution.

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