Investment Time Horizon Should Pick How You Measure the Results - Weekly Blog # 921

 

 

 

Mike Lipper’s Monday Morning Musings

 

Investment Time Horizon Should Pick

How You Measure the Results

 

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

  

 

 

Current Situation

Billions of people invest directly or indirectly in US securities markets, with each having somewhat different motivations and thoughts about what they are doing. Since we don’t know these people and the way they think, we simply group them into buckets. I have found the intended investment period often defines how they invest and for what period.

 

My outlook is of someone who has served families and institutions, and I tend to think long-term for them. As most money invested in mutual funds is largely for retirement and most institutions are designed to pay out their assets over an extended period of many years, they too have a long-term time horizon. (Unfortunately, this focus on the long term does not come with a knowledge of what the future will bring in terms of risks and rewards.)

 

The media concentrates on “news” and fills space with the current chatter about the present and the next expected announcement of note. Most security salespeople and money managers believe potential investors are primarily interested in the present and that is the focus of their sales pitches.

 

These two different focuses have led to two very different market structures. The hyper action-oriented players dwell on any market development that leads to a move in stock prices. They celebrate the percentage gains of interim results and prognostications. Those who use securities to meet future payments are concerned about anything that might reduce these payments in terms of future purchasing power. A possible tell-tale signal of a threat is the sale of securities by supposedly knowledgeable investors.

 

This is the tug of war between those seeking near-terms rewards and those worrying about the loss of worth of some future payment. To satisfy both camps the stock exchanges publish the volume of shares sold at higher and lower prices and the number of issues which rose and fell each trading day.

 

In the latest week there were only four trading days and one of those was half a day. On the last day the volume of shares traded on the NYSE was down by approximately 2/3rds and by approximately one half on the NASDAQ*. (In the current market environment, I pay more attention to the NASDAQ, as it has risen the most this year due to having more “Tech” companies, whose stock prices are more volatile than those on “The Big Board”. On Monday the 4 indicators were larger for the NASDAQ and on Tuesday the NYSE saw better results. This see-saw pattern has occurred frequently throughout the year.) For the week, 65 % of NASDAQ stocks rose in price vs 61% for the NYSE.

*Client and personal accounts own shares in NASDAQ.

 

In terms of looking at the future there were two interesting notices. The Conference Board Consumer Sentiment Survey was 89.1% vs 92.9% the prior month. The American Association of Individual Investors (AAII) saw a drop in bullish sentiment for the next six months in their sample survey, dropping to 37.4% from 44.1% the prior week.

 

Understanding the Measure

Most of the chatter about this change focused on the percentage change from the period immediately prior. However, there is another way to look at the results, the way an actuary would in determining the chance of a certain event happening. This is done by reviewing the entire history of the statistical sample, including any possible period where that event could reappear and at what frequency. For example, one chance out of fifty years, or every 84 months, or something similar. History traced through geological discoveries has recorded cycles of expansions and contractions with some regularity. It is much easier with regular barter or the development of money.

 

Said simply, when there is a shortage of supply over the level of demand, prices go up. When there is more supply than demand, prices drop. Climate also impacts agriculture, as does the effort of humans. The supply of money was a recent concern, which has more recently shifted to concerns about the supply of credit and certain natural resources. In all cases, it is the imbalance of critical items which moves prices to a point of excess, which causes a reversal.

 

Small reversals happen more frequently than large ones, often occurring within a single presidential term. However, small reversals periodically stretch over two or conceivably three terms. In trying to avoid or stop small declines, the application of well-meaning changes can trigger bigger declines, which we label depressions.

 

Addressing the economic hardships caused by the cost of fighting WWI led to an extended period of debt expansion, which initially hurt the farming communities. This led to the application of tariffs to protect small banks which extended loans to over expanded farmers and farm equipment dealers in critically important mid-western senate seats. Simultaneously, the public became enamored with the use of credit in an already highly priced stock market.

 

The market crash of 1929 caused many people to lose money in margin accounts, along with many of their brokers. The market reached a bottom in 1931, but people were scared by what had happened. In 1932 they elected FDR as President as a protector of the banks, and he closed all the banks in 1933 in an attempt to restructure society. Even though FDR lost most of his battles with the Constitution and the Courts, he initiated various government agencies that mismanaged the economy until we entered WWII, which he helped start in both the Pacific and Atlantic. The US recovered slowly after the war and subsequent Korean Conflict, although some stocks listed on the NYSE did not reach their 1929 highs until the mid-1960s with the discounted dollar.

 

Semi Parallels Today

There has been an expansion of debt both at the federal and individual level, with bankruptcies currently rising. At the same time, prudent constraints on the financial community have been reduced or eliminated. Additionally, we have an underequipped military, including Navy, Air, Space, and Coast Guard not ready for a multi-front war.

 

Conclusion:

We don’t know when the next decline will happen, or if the depth of the decline will morph into a depression. However, we should resist being fully exposed to rising gains in the non-public market while we experience a stagnant private economy. It is possible gains achieved in 2026 may be expensive in the long run, so be careful.   

 

 

 

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Confession: Numbers Don’t Tell All - Weekly Blog # 768

 

Mike Lipper’s Monday Morning Musings

Confession: Numbers Don’t Tell All

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

 

 

 

As a numbers-oriented person I must confess that numbers don’t reveal all critical information about a situation. For instance, future risks. The bearish financial press is focused on future profit margins shrinking on declining sales in the coming recession.

 

The real likely risk ahead of us is what an economic recession will mean to us personally. As Warren Buffet said, it will be revealed which swimmers are naked when the tide goes out. So too will we find out which companies are overextended when the economic pie shrinks.

 

The problem facing the management of companies, governments, non-profits, and individuals is the reduction of expenses. Rarely are expenses reduced proportionately to the actual decline in revenues, or the expected “top line”.  Expenses are cut either by judgement or happenstance. The cuts can impact the three “S” s on which future relationships are based. Products/services and future sales are based on their perceived Success in use, whereas Service is based on the ease of the relationship and the Safety of the user.

 

To an important degree the way customers feel about the product or service is dependent on the quality and quantity of known or unknown people they deal with at the firm and/or its distribution system.

 

The transaction price of most companies and practices are sold is leveraged over the resale value of its hard assets by its perceived reputation value. This is an attempt by the marketplace or ballot box to determine the sum total of the three “S” s. Thus, the impact on the absolute and relative value of its reputation is critical when it becomes necessary to cut people.

 

During the past holiday shopping season, it was easy to rank the service and inventory levels of various merchants through store visits. It was a little more difficult gauging the service levels provided by these service companies, particularly financial and health services. Much more difficult, but perhaps more important, is gauging the safety for the customer performed by service companies. Banks have announced employee cutbacks, hospitals are having difficulty finding qualified nurses and medical techs, certain military branches are understaffed in critical units, and law firms are reducing staff. These levels of safety should impact a company’s ultimate worth.

 

We don’t know what additional risks we are taking as consumers by relying on formerly reliable service providers whose staff support is shrinking. While I don’t know the risks, I do know that I am my accountant and back-office people are already spending more time reviewing the statements sent to us. I suspect the cost to me is much greater when a professional firm has an error or omission than when the wrong size of a garment is received at a store.

 

The following statistics suggest to me that I need to pay increasing attention to the details of safety than in the past:

 

Possible Warning Signs

1. The decreasing value of the US dollar relative to other currencies. This will likely raise the cost or reduce the quantity of what I buy.
2. There is a dichotomy between the level of transactions in the NYSE and the NASDAQ. Compared to a year ago, NYSE volume is down -14%, while NASDAQ volume is up +2%. Last week NYSE prices rose while NASDAQ prices fell. With many older company stocks generally flat for a year or more, the outlook for making money in these stocks looks limited. Some “growth stocks” are finding their sales more cyclical than in the past and the demographics are not promising.
3. China’s business capital returns are declining. Growth in global trade has been heavily dependent on Chinese export earnings. If they become smaller as the rest of the world slows, it is likely that export earnings will decline and result in lower imports.

 

Self-Appointed Mission

Bernard Baruch, a friend of my grandfather, labeled himself a speculator at a congressional hearing. He then explained to members of the House that the term speculator comes from the Latin term “to see far”. I use a speculative focus on the future for me and my clients. Part of looking at the future is identifying different possibilities. I take my marching orders to spot both “bull” and “bear” cases.  

 

My blogs often warn of problems, as Mr. Baruch did. However, I think the time for a new “bull” market is coming. Hopefully, we will make enough adjustments to our society/economy so that we won’t need to go through stagflation to adjust.

 

I lack the ability to see the future. Hopefully, a few subscribers to these blogs will have some thoughts they are willing to share about the next major “bull” market. (Please don’t focus on inflation and interest rates which are old news, they are attributes, not causes.) Help!!

 

 

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Week in Conflict Leads to Buy List - Weekly blog # 764

Mike Lipper’s Monday Morning Musings

Week in Conflict Leads to Buy List

 

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

            

 

 

Trading Didn’t Tell Us Much 

Over-simplification: Buyers largely believe that inflation is the sole problem facing the market and the Federal Reserve will take care of it by managing short-term interest rates. As the stock market went up the first two days of the week, more shares transacted at rising prices. 

 

The next two days saw prices decline in reaction to a greater than expected fall in November retail sales. Department stores led with a more than -2.5% decline compared to an overall average decline of -0.6%, vs. an estimated decline of -0.2%. (Visits to the high-end The Mall at Short Hills in early and mid-December saw a lack of salespeople, incomplete stock, and vacant stores.) There is a second group of investors, some of which were trading and many more not. I call them Realists. 

 

Friday’s transactions were partially misleading in that over $4 trillion dollars’ worth of options came due. Options users often hedge individual securities, exchange-traded funds, and other derivatives. On Friday both the NYSE and NASDAQ traded over 5 million shares on the downside, vs. a total transaction count of 5.4 million shares on the NYSE and 5.5 million shares on the NASDAQ. (Remember, about 40% more shares were traded off the exchanges.)  1.7 million and 2.4 million shares were traded on the upside. (Thus, I am not sure how to interpret these actions, other than them giving us a clue on the size of the speculative market.)  

 

Although the believers will hopefully be right, it does not appear it will be soon. Economists have created an index of leading indicators which are still going down by about 1% per month. The believers, particularly those that are Washington oriented, focus on national numbers. They do this because it leads them to policies where they can harvest votes. The realists are more attuned to measures that track the wealth of the country and the world. This year the aggregate wealth on main street has been rising due to an inflated sample of real estate prices rising faster than public portfolio values have been declining. These people recognize their good fortune but worry about inflation and the decreasing purchase value of their currency. 

 

A leading retail-oriented broker indicated their clients have been buying mostly corporate/municipal bonds and commodities, while selling declining US government bonds. Thirty-year bonds have fallen 35%, the worst in over a century. (Never have they fallen 3 years in a row.) 

 

Commodities are finishing the year as the best asset class for a second consecutive year. Commodities are going up in price because of actual and perceived shortages, both at the industrial level and to a lesser extent at the food level. When demand drops for industrial goods in a dampening economy, some commodity prices will also drop. This is exactly what OPEC+ fears, a fall in demand.) 

 

Brokers also see a sharp increase in the purchase of tax-exempt bonds. Many of these bonds are backed by expected state and local income taxes. These revenues will likely drop when individual and corporate income drops and won’t be meaningfully offset by rising rates for political reasons.

 

Thus, in an attempt to preserve investor wealth and purchasing power, a major portion of their wealth may be exposed to rising interest rates and a decline in purchasing power. After which rates could fall if “The Fed” reduces them. It is exactly the reason I am suggesting long-term prudent investors begin investing a portion of their assets in something that was previously mostly attractive to seniors. 

 

Tactical Reserve Preparation 

This time it’s different in that capital is being temporarily retrieved from risk assets. (The length of time out of the market will be determined by changing investment and personal conditions.) Since none of us know what the future will bring, we should utilize some of our money to defend against the possibility of stagflation, which could last ten years or more. This has happened twice in the last century.  

 

The tactical reserve is best structured by buckets. One bucket being long-term oriented and another short-term. The latter would be kept in locally deposited savings accounts, money market funds, and 2 year or shorter US Treasury paper.  

 

The larger portion, or perhaps the total of the tactical reserves should be invested in Equity Income stocks, an old asset class that is slowly becoming available. For many years these investments were difficult to find due to low interest rate yields. 

 

Currently, 2-year US Treasuries are yielding 4%. In this weekend’s WSJ I was pleased to find 48 stocks out of list of the 1000 largest equities yielding above that number. My filter was common stocks yielding between 4.0 and 5.99% whose price/earnings ratio was below 15x. Every investment has risks and those with yields of 6% or more are believed by the market to have some capital risk. Also, stocks with a P/E above 15 may not have earnings approximately equal to twice the current dividend. Most of these companies regularly raise the dividend at least as much as inflation. Another helpful characteristic is a significant number of shares being held by a family or other interested parties, like some pensions, endowments, and income oriented mutual funds. 

 

While there is some portfolio diversification in the list of 48, it is not as diversified as the broad-based market indices. The largest common denominator on the list is financial companies, with a heavy collection of domestic and foreign banks, particularly Canadian. The list includes Citigroup. Real estate and utilities are also prominent. I was pleasantly surprised to see 3 fund management company stocks I own in order to participate in a growing financial services business. Furthermore, there were names of major holdings in the investment companies I own. I also found some names of stocks I should investigate for inclusion in my tactical reserve or other portfolios. 

At this point the task shifts from security selection to portfolio construction and ongoing management. As we are building a tactical reserve, we need to avoid unnecessary exposure to losses. The first rule is to reduce risks by diversification. The best way to start is to have a beginning portfolio of at least five holdings, which hopefully will grow to ten distinct holdings in time. Pick your holdings from each of the sectors - Domestic banks, foreign banks), non-bank financials, life insurance, property owners, energy providers and servicers, industrial producers of needed products, and utilities. (Some pay dividends in dollars while making their money in different currencies, including commodity aided currencies like the Canadian dollar.) Be careful to limit the maximum single holding to twenty percent of this account.  

 

When operating the account, small cash distributions should be transferred to the cash account. If the prices of the holdings drop ten percent more than the market, stop buying. If prices fall twenty percent or more, consider selling half or all the holding. 

 

Remember, these operating procedures are suggested for the tactical reserve account. A different set of rules and procedures would be more appropriate for accounts having different target dates for payments. The other important thing to remember is that the quicker an investor learns humility, the bigger the ultimate return.    

 

For long-term subscribers who will share their intended use of the list with me, I will make the list available to them.   

 

 

 

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Mike Lipper’s Blog: What does your 4.0 Profile Tell You? – Weekly Blog # 763

Mike Lipper’s Blog: Week Divided: Believers vs Investors – Weekly Blog # 762

Mike Lipper’s Blog: This Was The Week That Wasn’t – Weekly Blog # 761

 

 

 

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Is This Great Investment Era Ending? - Weekly Blog # 728

 

Mike Lipper’s Monday Morning Musings

Is This Great Investment Era Ending?

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

In recorded financial history two of the most important tools are Gresham’s Law and Arbitrage. Applying these tools may aid in thinking about the current decline in stock prices, which is likely to evolve from a cyclical bear market or a secular change into a structural change. (As with any prediction of the future, the analysis of the present can be incomplete, leading to incorrect judgements. Recognizing these risks, I hope it is useful to analyze the present and speculate on the future.)

The following observations may be germane to the analysis:

1. Most governments want to stay in power and attempt to do so by growing the money supply, providing food and other critical resources to keep most of the population tolerant of them. As with any gifts, there are costs disguised as taxes and restrictions. These “gifts” have now become very expensive, generating excessive inflation and lower currency values, which in turn impacts purchasing power.
2. Many restaurants and other retail establishments no longer take coin of the realm, but only accept credit card payments.
3. Around the world there is increased demand for crypto currency vehicles.
4. The invasion of Ukraine by Russia has focused countries on critical shortages of energy, selected other minerals, fertilizer, and most importantly food.
5. Wars are often fought between countries perceiving near-term differences in their supply of critical needs. We are approaching the possibility of a different kind of World War. Instead of East vs West, it is likely to be North vs South, with northern populations declining and southern populations growing. This sets up a transfer of resources and relative power.
6. No country has an absolute mastery of technology.
7. Global mass-communication implies widespread dissemination of both correct and incorrect information
8. Relative investment performance no longer favors the generation of sales, earnings, net cash, investment income, and similar measures vs the attraction of future products and services. (Within their respective investment leagues there are new leaders without much benefit of history or success.). 

Please add your own observations and communicate them.

Gresham’s Law came out of the observation that when governments use a less valuable currency in place of older coins with a higher mineral value, the holders of the older currency hoard it. In terms of usage, the less valuable currency drives out use the more valuable currency. Is that happening today?  If it is happening, how will economies restructure under that pressure?

One standard analytical technique is to look at an object, such as real estate or an artwork, and differentiate it from other measures. One wishes to own the lower priced instrument, hoping it will graduate to the level of the higher valued instrument. Sometimes it works, but the real value is the perceived price differential, which becomes an article of faith.

Just as Latin American Gold changed the entire European economy for approx. two hundred years, changes resulting from the imbalances observed above will likely have substantial ramifications for us all, especially for our heirs.

What do you think?

There are a lot of things happening that can be described as pointing to the upside, despite a negative picture overall. There are five mutual fund peer groups averaging better than 20% year to date: Natural Resources +31.55%, Global Natural Resources +22.86%, Energy MLP +22.26 %, Commodity funds +20.70%, and Latin America funds +20.54%. Similarly, there are commodity pool peer groups holding futures or commodities: hogs +27.5%, wheat +25.2%, soybeans +23.4%, orange juice +22.7%, and sugar +22.5%. It appears the invasion of Ukraine may have a bigger impact on the global food supply for Europe and China than energy. It may be fitting that this change is appearing now, as we close a financial, economic, and political era.

We should now begin to look carefully, finding what will work for us as well as against us. We are due for surprises and some difficulties, along with some victories.

Thoughts?                 

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

https://mikelipper.blogspot.com/2022/04/wwiii-slightly-delayed-bear-market.html

https://mikelipper.blogspot.com/2022/03/not-much-weekly-blog-726.html

https://mikelipper.blogspot.com/2022/03/relative-or-payout-returns-in-periods.html 

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Relative or Payout Returns in Periods - Weekly Blog # 725

 

Mike Lipper’s Monday Morning Musings

Relative or Payout Returns in Periods

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

Throughout life we learn that successful investing is an artform, which means that people with different perspectives view actions differently at different times. Thus, no single investment fits the needs of everyone. With that starting point, we believe successful investing is going to be different for each of us and should not be taught based only on numbers and regulations.

I believe the single most important starting point in investing is identifying the period of investment. Our current culture is very much focused on now, with the media reinforcing that view. To the extent a future period is mentioned, it is tomorrow, next week, month, or year-end. Even when we state the decision period, we don’t describe the terminal date. For example, we know that US stocks on average produce high single digit returns for long periods of time. Thus, an 8% return for 2022 could be forecast. That could be considered a good or bad return compared to alternatives. Early this week, a positive return half that size could have been acceptable. By the end of the week, any annual return below 20% would be considered dismal.

The financial and popular media place us in a relative world, making comparisons of what they believe are competitive investments. After all, stock prices are subject to the same risks and rewards! This is a gaming or gambling attitude. Most of the money we are responsible for use current investments to produce total returns for use in future periods. Consequently, we think about returns compared to the expected uses of the money, with sufficient excesses to cover periodic shortfalls. While the size of the excess pool could be based on actuarial assumptions, it is more likely to be a comfort factor. (One reason many bear market survivors don’t do well in future periods is that they carry with them the fear of even worse future markets. It is quite possible that after a large decline one should reduce the size of the excess reserves.)

PORTFOLIOS STRUCTURE

The first recommended step is to sub-divide the investment portfolio into time-focused sub portfolios. Considering the current unsettled global, political, and financial conditions, I suggest the first sub portfolio cover expected payments between now and the end of the first year of the next president. The excess over payments might be in the order of 30%, declining as stock prices decline.

The second sub portfolio should cover the period after the first, perhaps going through the expected lifetime of the principal owner. The reserve component should be no more than half the first sub-portfolio, because based on history markets generally rise 75% of the time.

The final sub-portfolio should anticipate being expended after the expected lifetime of the principal owner. The volatility reserve should be half of the second portfolio’s.

ASSINGING CURRENT MARKET DATA TO PORTFOLIOS

Caution: My investment views are for the most part contrarian to popular views. They take advantage of the historic experience that when contrarian views succeed, they have a larger payoff than popular views, whose benefits are usually already in current prices. However, contrarian expectations do not come into fruition as often as popular views.

Immediate Portfolio

The American Association of Individual Investors (AAII) six-month sample survey shows 22.5% being bullish and 49.8% bearish. Extreme readings are normally under 20% and over 50%. Market analysts use this as a contrary indicator. (When these numbers reverse, watch out.)

Up and down transaction volume is also something of a contrarian indicator. In the week ended Friday, the NYSE had more shares moving up than down, 20 million vs. 10 million. Normally they are more balanced. After a long period of declining prices, the next upward spike is often caused by short sellers or custodians buying to cover shorts that need to be liquidated. While the relief rally on at the “big board” gained all five days of the week, the DJ Transportation Index was up only 3 days, and the Utility Index was up only 2 days. (Unless the upward movement broadens out, the rally may not be able to sustain itself for long.)

Working Portfolio

According to a recent survey of institutional managers, growth stocks were not favored over value stocks for the first time in many years. Since 2007, the MSCI ACWI ex US Growth index has been flat (Morgan Stanley Capital International All Country). (If this view is maintained, the relative multiple of growth price/earnings ratios will decline and represent a bargain at some point. But it also may suggest that earnings will grow at a materially slower rate. Another possibility is earnings outside of US Growth companies growing faster than those in the US, along with their stock prices.

Estate Portfolios

Each week Barron’s publishes the performance of the 25 largest US Equity Oriented Mutual funds from my old shop. Only five management companies placed funds on this list: American Funds (Capital Group) - 10, Vanguard - 9, Fidelity - 3, Dodge & Cox - 2 and PIMCO - 1. The total net assets of the funds range from $125 billion for Growth Fund of America (Capital Group) down to $53.8 billion for Vanguard Wellesley/Adm. (Note: all these funds have been serving investors for many years and American, Vanguard, and Dodge & Cox have done a good job of capital preservation. This may be important to their fund holders and distributors, although at some point in the future I expect to see more capital appreciation-oriented funds on the list, at least for a while.)

In all the discussion on the availability of petroleum, politicians and US Government people forget that the Bakken reserves represent over 500 billion barrels and would last for more than 100 years at current consumption levels. I believe the combination of our fuel and refinery expertise makes this supply one of the cleanest in the world. Considering the declining number of US based refineries and the low margins in the business, there could be a temporary bottleneck that could be addressed. (Whether an investment management organization has a direct investment in energy or not, I believe a knowledgeable energy analyst is essential for a successful portfolio management business in the future.)

Question of the Week:

How much of your portfolio is focused primarily on relative returns vs meeting payout needs?

  

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

https://mikelipper.blogspot.com/2022/03/building-your-future-winning-portfolio.html

https://mikelipper.blogspot.com/2022/02/successful-investing-expects-unexpected.html

https://mikelipper.blogspot.com/2022/02/we-are-progressing-weekly-blog-721.html

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