What is Pending and When - Weekly Blog # 947

 

Mike Lipper’s Monday Morning Musings

 

What is Pending and When

 

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

 

          

 

Who is Foreseeing?

We are entering a new phase at the Federal Reserve Bank where the new chairman wants to look to the unknown future rather than recorded history. He is searching to find a different set of indicators than government collected survey data. I always thought that the lunch discussions presidents of the local reserve banks had with “captains” of local industry were an attempt to gather this data. I believe what he is looking for is the kind of inputs many companies gather daily or weekly. (I knew the number of subscribers for each of our fund data products plus the number of new subscribers each week. Additionally, I knew the number of special individual reports generated, and the amounts of commissions earned each week.) I hope he gets what he wants, it will probably improve the efficiency of what the Fed decides.

 

My big complaint to the members of my securities analysis profession is that most of their reports focus on relatively short-term investment performance: the quarter, the rest of the calendar year, or one year. While that has some value for the media or gatekeepers, it has very little analytical value.

 

In viewing the work produced under the rubric of Securities Analysis, it is important to remember that the original text on the subject was written by Ben Graham, an investment manager and adjunct professor who favored “cheap” stocks. He was assisted by David Dodd, a full professor at Columbia University who taught accounting courses. Their original text was written in the middle of the depression. The key to their writing and financial survival was to avoid losses. Little attention was paid to making money, which came later. This bearish bent was echoed in the SEC’s Investment Company Act of 1940, which was not written by members of the SEC or their staff, but by a bunch of trust lawyers with heavy input from lawyers in Boston, New York, and Philadelphia. For them, the key issue was avoiding large losses and being sued. I took Securities Analysis under Professor Dodd at Columbia.

 

The More Modern Era

One could selectively make money by venturing into the market with new listings trading at a discount. An approach highlighted after WWII when war industries recommitted to the commercial world with new high energy leaders. However, far too many of the new ventures of the late 1940s produced large losses for their investors. By the late 1950s more pragmatic leaders emerged, with the “bull market” of the 60s bringing new generations into the market. The fear of losses ebbed in the late 60s, resulting in  the idea of some leading stocks being held forever. This led to economic decline and a downturn in market enthusiasm which lasted into the mid-1980s. Since then and up to this calendar year the emphasis has been on making money, not avoiding losses.

 

We Have Possibly Entered a New Era

In last week’s blog I suggested that the critical market indicator has shifted from the Dow Jones Industrial Average (DJIA), from the late 1940s through the mid-1980s, to the institutional Standard & Poor’s 500 (S&P 500) from the mid-1980s to until very recently, and in the current period to the NASDAQ Composite. This week the DJIA was up 3 days and the S&P 500 was down 5 days. The NASDAQ was also down 5 days, but by a larger amount each day than the S&P 500 institutional measure. This seems appropriate as it rose more, driven by “AI” and the technology craze. I believe it is sensible to label this a technical correction.

 

More concerning is the market sensing a change in our future. Much of the current leadership comes from the retail side, whose increased numbers were driven by the conversion of retail brokers becoming wealth managers to earn a fee rather than a commission. The significance of this shift is that for the first time investment performance will be measured on the retail side. These new “managers” may panic and be quicker to sell than the institutionally oriented mutual fund portfolio managers. We may already be seeing this in redemption rates and attempts to redeem closed-end target date funds. Institutions have long experience with the cyclical results of below investment grade debt. Is it possible retail investors will lead the whole market in worries about declines?

 

Are There Reasons to be Worried?

I believe it is too early to be categorical about the next major decline, though I do believe it could happen. The following are potential signs of one or more major declines. (Going back to my course with Professor Dodd, I believe we should be prepared for the following pending triggers to generate meaningful declines.)

• The biggest potential trigger is that we have not experienced a depression since the election of FDR in 1933, which did not end until 1942 because of his mismanagement. Skipping several cyclical recessions, the prior depression globally was in 1873. Thus, it has been 93 years since the beginning of the last depression or 84 years since it ended. (Depressions are caused by mismanagement and too much debt in the financial system.) The present administration, by personality, not policies, is very similar to FDR’s.
• The surprise to the leaderships of attacks on Bahrain’s US Naval Base and Ukraine’s attack on Crimea. The nations hurt were thought by their people to be prepared for these attacks. Both nations have people worried about their country’s intelligence and governance.
• Changes in Federal Reserve governance may be destabilizing.
• ACA Insurance healthcare payments showed unexpected reductions.
• Lack of progress on addressing Social Security solvency
• Focus on innovation, but only on the mechanical side. In the US innovation typically has a bigger impact on sales size and structure.
• Quality of schooling and home life vs. education retards growth and military preparedness. Probably negatively impacting marriage and childbearing.
• Legal immigration

 

For the last 10 years only the average Large Cap Growth and domestic global Science and tech funds have beaten the S&P 500 Index fund average. For the current year-to-date period, 57 sector averages did better out of 104 equity sectors. The game has changed.  

  

What are Your Thoughts About?

• A possible Depression?
• What are we not prepared for?
• Will the 2026 election decide anything?
• What will the 2028 election decide?
• Any other thoughts or comments?

                                         

 

 

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Mike Lipper's Blog: Too Many Short-Term Worries To Pick Long-Term Winners - Weekly Blog # 946

Mike Lipper's Blog: Is This the Last Hurrah? - Weekly Blog # 945

Mike Lipper's Blog: New Era? - Weekly Blog # 944

 

 

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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. 

                                        

 

 

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

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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4%, 5%+, Changes, Disruptions, Faulty # # - Weekly blog # 748

 

 

Mike Lipper’s Monday Morning Musings

 

4%, 5%+, Changes, Disruptions, Faulty # #

 

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

    

 

Particularly Difficult to Invest 

Pundits have an advantage over real investors. They eliminate any factors contrary to their proclamations. I don’t have that capability in deliberating how to invest for the multiple futures faced by my accounts. The somewhat obtuse title of this blog is a shorthand list of my concerns.  

 

4% 

4% is my conclusion after listening intently to Chairman Powell’s less than 9-minute speech concerning the Federal Reserve Board’s direction. While it did not reveal much new, it reinforced earlier comments made at the last press conference. It reaffirmed my belief that the minimum interest rate that should be expected is 4%. My belief is anchored in a co-incidence. Most money in the market is invested to meet retirement and estate needs. Long-term research suggests annual withdrawals from these funds should be 4%, which implies leaving the on average basic capital intact after inflation and taxes. If that is the goal for both private funds and social security payments, it requires capital growing at least 4%. This 4% aspiration is higher than the current return earned by Social Security and other government funds. Thus, the basic requirement for a sound economy is 4% growth. 

 

The drop in stock prices on Friday was probably due to expectations the Fed would show signs of “pivoting” toward lower interest rates. Investors should not let wishes drive expectations! 

 

5%+ 

Reported general US inflation is running at 8% or more. Chairman Powell and other Fed leaders have indicated the appropriate Fed interest rate should be sufficiently above the inflation rate to assure consumers and others in the market that rising inflation won’t be a future problem. 

 

The current focus of the Fed and others in government is the belief that they can only accomplish their goal by reducing aggregate demand. This is what is taught at most universities. Advocates of this view have little if any experience in the commercial world. They believe in dropping the level of the water when a tall vessel approaches a low hanging bridge. I and others in the commercial world believe the bridge should be raised, probably permanently. 

 

In terms of current US inflation, the current administration is lowering the water. Energy is probably the largest single contributor to inflation around the world, yet the US government is curtailing its availability. Other constraints placed by the organs of government on a productive economy are various regulations. Without changes, odds are low the US will see inflation less than 5%, and it may be well above. 

 

There is a good chance that assets other than US currencies will appreciate when the Russian-Ukraine war ends and/or when the Chinese government is successful in growing its economy again. Thus, it is appropriate to assume the US dollar will decline in value at some point. Goods and services purchased from overseas will then be priced higher, adding to our inflation. 

 

Changes 

There are likely political power changes coming to the US from both the mid-term and presidential elections.  

 

In the current recessionary environment, we are seeing various senior portfolio management and asset management leadership changes. Many corporate boards of directors are unwilling to continue with their current top management, or even continue to allow their degree of independence. (This could be an early gift to slow moving “value” stocks.)  

 

Disruptions 

One influencer of goods inflation is inflation in the service sector. Customers in supermarkets and malls have changed their buying habits to get more value and less fashion from their purchases. This change has been noted by producers of consumer goods. They have reduced advertising support for some fashionable top-line merchandise. 

 

The reduced support has already led to lower expected revenues for the big five advertising agencies. Broadcasting networks are in turn worried about revenues from these advertisers. At least one network is considering dropping an hour from its prime-time programs. I suspect competition from cable and streaming channels is also chipping away at network audiences. 

 

Another disruption is life insurance sales being down from peak-levels during the pandemic.  

 

A final disruption is the value of real estate. Commercial real estate is carried as an asset on corporate balance sheets. For the most part it is carried at purchase price less “depreciation”. This gets to the heart of the problem. Accountants and asset owners don’t like being sued for inaccurate financial statements. Consequently, they carry their assets at costs less amortization of their purchase prices unless there is a rare contrary price available. 

 

Take an office building costing $1 million being “depreciated” $25,000 each year, straight line. At the mid-point of its theoretical life the property value would be listed as $500,000. The accounting rules would not permit raising the carrying value to $750,000 if a comparable property was sold at that level. Nor would it drop that valuation to $600,000, a drop of 20% if there was a lower priced sale later. Consequently, the owner would carry the building at $500,000 that year. Thus, there is a $100,000 “hidden value” that many “value investors” prize. 

 

Now, bringing the situation up to date. The present tenants have indicated that they only need 25% of their space due to work from home syndrome. They threaten that they will move out unless the rent is adjusted to their needs. If this were to happen in the midpoint year, the real value of the building might be $150,000, (25% of $600,000 if that price is still accurate.) The problem for an uninformed value investor is that this price is considerably below what the investor thought. 

 

Conclusion: 

These are uncertain times. While some of the uncertainties will be solved, they will not be solved at today’s prices. So prudent investors should move cautiously and probably divide their transactions into parcels for periodic transactions. They should not try to pick a bottom or jump on a sharply rising trend. 

If you have different views, please share.  

  

 

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

https://mikelipper.blogspot.com/2022/08/mikelippers-monday-morning-musings.html

 

https://mikelipper.blogspot.com/2022/08/time-to-prune-weekly-blog-746.htm

 

https://mikelipper.blogspot.com/2022/07/time-to-be-contrary-weekly-blog-741.html

 

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Uncertainty is Inevitable - Weekly Blog # 697

 

Mike Lipper’s Monday Morning Musings

Uncertainty is Inevitable

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

Numbers and People Are the First Traps

When a baby takes its first uncertain steps it eventually falls, despite hovering caregiver parents and others. From that instant on, the baby wishes to avoid falling. As we learn to balance our movement, we believe we have solved the problem of safely walking. Thus begins our first mistake in judgement which we apply to all activities, including investing in life and securities. While we fall or stumble less frequently throughout our lives, we accept it with annoyance, but carry on nevertheless.

Our next mistakes are our imperfect memory and learning from people. We expect those we love and/or respect to be correct in their pronouncements all the time. Only from experience do we appreciate that they can and will make mistakes. Later in our development we learn the discipline of the power of numbers, usually through achievement or time. However, we also learn that conditions change, and success or failure also changes with conditions. Thus, we should question the inevitability of future events occurring exactly as people and the numbers foretell, as uncertainty changes as we mature into risk. Whether we like it or not, we become risk assumers or hopefully risk managers.  My philosophy of life and investing is based on addressing risks whenever possible. This blog is devoted to some of the current risks I perceive, which are generally not focused on by many professional and individual investors.

1.   Sellers’ Risk

Most people view the buyer as the one at risk in any transaction. While this is true in terms of money transferred at closing, including expenses to make desired changes and upkeep, what most don’t fully recognize is the seller in one transaction becoming the buyer in the next transaction. Home prices recently reached record levels in the US, the UK, and many other developed markets. As these homeowners become sellers and eventually new buyers, they will bear the initial cost of a new home, including its desired changes and upkeep.  

Many buyers are at risk due to the vagaries of current inflation, including through delays. Most communities have not updated their infrastructure, apparent after the latest weather-related expenses, which will increase costs. I suspect local schools and universities will need to change the education being taught so their students can find meaningful employment and lives. (This will increase taxes and won’t be cheap)

2.   Co-Venture Investment Risks

In almost any investment one of the bigger risks is attempting to sell. One or more sellers can “ruin” the market by removing though sale a higher buyer. This can happen in terms of a neighbor’s home, a similar property, or a fellow shareholder. The probable or contemplated seller’s actions are difficult to guess, but it should be attempted.

Let me share an example that happened this past week. A non-US stock I own announced a 29% decline in net income for the first half of 2021 and the price barely moved. Yes, revenues rose 54% and they announced a few new items to replace outmoded products. While I was surprised by the net income decline, I was not particularly surprised by the stock price action of BYD. [These comments should not be construed as a recommendation, in part because I don’t follow its industry or its competitors.] My relative lack of concern comes from knowing two of the largest stock investors and having visited the headquarters and plant in Shenzhen. In looking to the nature and reputation of major shareholders, I relied on one of the oldest investment techniques, identifying sponsorship. 

A story that has been told from the 19th century involves a leading member of the London Stock Exchange asking another member what he could do in repayment for a favor. Replying to Lord Rothschild, he said “just put your arm around me and walk across the floor of the exchange”. With that in mind I regularly look at the owners of stocks of interest. Some funds have high portfolio turnover rates and tend to look for explosive earnings. Others, like the two owners, are long-term investors who would probably be buyers if the stock dropped temporarily. Currently, with 20 million new retail accounts since 2020, I don’t expect many to have learned to be buyers of shares that are declining in price.

3.   Market Price Leadership Rotation 

The current leading macro group investment is commodity funds, benefitting from the play on current shortages. Combine this with what I previously mentioned, some institutional investors cutting back on equity exposure after 20% gains in the S&P 500 within a calendar year. (The difficulty with this approach today is the lack of low-risk alternatives to move some stock money into.)

4.   A Potential Large Risk for the Next 3 Years

In addition to the current legislation before Congress, which is not likely to be paid for during their expenditures, there are at least two other issues Congress will need to deal with sooner or later. The current administration is discussing cutting the income tax rate on lower earnings. (I suggest it be called “lower real income for lower wages”.) A portion of the low wages paid to those who pay little if any income taxes is not likely to increase spending. To offset the cost of lower taxes on low wage earners, one should expect materially higher taxes for higher earners (This is the real motive of certain people in The White House and of far-left leaning members of Congress.) 

To offset this increase, higher rate taxpayers are likely to see prices rise for goods and particularly services. If it continues long enough, the cost of transportation and other items for low-end wage people will also rise. As profit margins decline, more business will flee the country and/or reduce risky investments. The increase in the price of oil already demonstrates the skill of the current administration. Words from the White House suggest the economic impact of the new proposal will be measured against “the success of our withdrawal from Afghanistan”. 

5.   A Longer-Term Problem that Must be Addressed

The Old-Age and Survivors Insurance, the largest component of Social Security, will run out of money in 2033. Undoubtedly this will be met with tax increases and probably a lower value dollar, which will hurt investors who are not properly hedged.

Share with us what you are doing now

Either for attribution or privately, just to help me in my thinking.

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

https://mikelipper.blogspot.com/2021/08/possible-major-change-missed-by-media.html

https://mikelipper.blogspot.com/2021/08/another-but-discouraging-look-at-market.html

https://mikelipper.blogspot.com/2021/08/mike-lippers-monday-morning-musings-are.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

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Contact author for limited redistribution permission.