Investors, Politicians, & Other Children - Weekly Blog # 745

 

 

 

Mike Lipper’s Monday Morning Musings

 

Investors, Politicians, & Other Children

 

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

    

 

 

Most investors, politicians, and other children act as if they are the only people that have had to deal with behavioral challenges. However, there is very little in life that is totally new, only the packaging has changed.

 

For example, how should one measure progress, and should it cause action? Most of us have some level of confidence in reported numbers, although numbers are an abstraction of a reality, not reality itself.

 

We are all counters from an early age, and since tradeable money was created have tended to count many of our successes and occasional failures in monetary terms.

 

The problem is the value of money is in the eyes of the beholder. One hundred million Confederate dollars has very little, if any value today.

 

Those dollar bills were on the losing side of a painful war, but we have been on the losing side of an age-old battle since birth. That depreciating value is called inflation.

 

The crux of the problem is the creator of this vehicle of exchange is also one of its largest users. Furthermore, the ruler of the mint or printing press is in a position of strength due to support from the right people. The easiest way to keep their loyalty is to pay them. In imperial Rome it was called “bread and circuses”.

 

In many Roman cities and towns, the amphitheater was larger than the nearby fortress. These were the entertainment centers for the populace who had enough food to eat due to an efficient agricultural system with well-engineered aqueducts.

 

I find it revealing that today’s name for giving money indirectly to the population is derived from a Latin word for stimulus. In earlier days it was called a bribe.

 

When a long-distant trader, Marco Polo, worked along the long Silk Road (1271-1295), the most advanced society was the Chinese empire. It developed gun powder and later developed paper money. Not surprisingly the empire had a large government, with examinations for jobs.

 

From my standpoint, smuggling silkworms back to Europe created a market-based exchange with a sounder form of money, especially when compared to their traditionally weakened currency. This is the way he delt with inflation.

 

In the thirteenth century the Europeans were somewhat protected against inflation due to small indigenous silver mines whose content went into their currency. This lasted into the next century and was replaced by gold and silver produced at low wages in Latin America, starting about 200 years of inflation.

 

When the steady stream of gold dried up the overseas colonies of England and other European countries became too expensive to maintain without substantial taxes. This is the reason a political group in England was not disappointed with the result of The American Revolution.

 

Confidence in the Future is Low

There are a plethora of signs showing this lack of a defined future:

• What are yields on US Treasuries saying? 2-year Treasuries are yielding 3.25%, 10-year Treasuries 2.84%, and 30-year Treasuries 3.07%. The 2-year is inverted relative to the 10 and 30-years!!

•  All 3 of the AAII survey predictions for the next 6 months are in the 30-39 % range.

• While 53% of the DJIA companies were winners for the week, the DJIA lost value in aggregate points. By comparison, only 40% of the companies in the Transportation index were winners.

 

• The JOC-ECRI industrial price index dropped 5.15% year over year.

 

• Exchange traded equity funds continued to suffer redemptions, led by growth and value funds.

 

• Liz Ann Sonders, the highly respected chief strategist from Charles Schwab is not bullish because she has not seen the market capitulate, as would normally be the case near the end of a bear market.

 

My Views

I have been searching for reasons to be optimistic for our long-term investment accounts, as after every bear market there is a bull market.

 

I agree with Richard Bernstein that bull markets don’t start with narrow leadership.

 

I believe economic and market cycles are not just number exercises, which you might be led to believe after reading columns from the various pundits.

 

I believe cycles are critically needed to address severe imbalances, not just trading opportunities. In previous blogs I have listed troubling demographics quality of schooling, healthcare, military strength, and leadership.

 

As I do not see these imbalances being addressed, I am afraid we will experience one or more recessions. There is a popular hope we will avoid a recognized recession, or only suffer a mild one.

 

If that were to happen, it would not likely sufficiently address our problems. I have no doubt our politicians can continue to produce a smoke screen to hide the issues. The current proposed legislation is an example of this, almost guaranteeing a major recession in a couple of years.

 

If that were to happen, much like during Paul Volcker’s tenure where he had two recessions, there would be substantial risk of a needed recession with very high interest rates.

 

I look forward to a new bull market with some answers to our problems, even after that experience. Our families will need one.

 

Please comment.

 

 

 

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

https://mikelipper.blogspot.com/2022/07/weather-market-economic-and-political.html

 

https://mikelipper.blogspot.com/2022/07/beware-of-cheap-seek-fair-slowly-weekly.html

 

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

 

 

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Copyright © 2008 - 2022

 

A. Michael Lipper, CFA

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Best Bet: More Sweaters and Parkas vs Overcoats - Weekly Blog # 708

 

Mike Lipper’s Monday Morning Musings

Best Bet: More Sweaters and Parkas vs Overcoats

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

I don’t like to lose bets, especially investments bets. That being said, I am highly confident those in the northern hemisphere will suffer a colder winter than expected. The streams of cold weather from Asia which flow over North America and Europe are moving south this year and will bring a colder winter to the US. (This contradicts “global warming” or climate change predictions.) The second and preventable driver is the need for politicians to be re-elected.

The only game that counts in Washington DC is getting elected, which importantly is based on money deployed from all sources. Despite food prices reflecting rising transportation costs, the central government is determined to hurt the states supplying energy for heating. Three states in particular are being targeted: Wyoming, West Virginia, and Texas. The first two are the leading exporters of coal to the rest of the nation, with Texas being the leading exporter of oil and gas. (Natural Gas is a major source of heating for much of the northern portions of the country.) These three states have significant Republican majorities, both in terms of votes and more importantly political contributions.) 

The game of war often relies on misleading the enemy regarding your intensions. In Washington this is done by a friendly media focusing on stimulus, even though it is a major contributor to inflation. While inflation is the cruelest tax on the poor, those in power believe the loss of some votes in the city districts won’t endanger the city progressives.

There are already a lot of predictions regarding the sharp rise in the cost of heating this winter. Landlords, already having difficulty collecting rents, may cut the amount of heat. Non-profits, including government bodies without actual or equivalent “rainy-day” funds, may face similar problems. Schools in low-income areas may similarly have shortages of students, teachers, and administrators.

Many of the aggrieved or their representatives will appeal to the media for help in sweaters (inside) or parkas (outside). Those appearing in overcoats will be considered tone-deaf, no matter how well intentioned.

Faulty Responses

Many of the shivering responders shown on television will emphasize the spike in heating costs causing an increase in “common colds”. The number of non-workers will be blamed on “acts of God”, due to shifts in northern wind blasts. They will not likely admit that part of the problem was self-administered, either out of The White House or Capitol Hill. By curtailing the capital generation of energy producing industries the government has caused the US to be an energy importer. It is no longer the net energy producer and exporter it was two years ago. They did this by causing pipelines to close, or not be built at all. Furthermore, in a stretched global market for oil, bureaucrats are increasing the industry’s burden by holding price investigations.

Multiple Year Transitory

As is often the case, economists look at the top-down government numbers of goods produced or shipped for problems, not the services or labor required. In their calculation of supply chain shortages, they fail to recognize the nature of the labor shortage. Not only are entry level workers missing, skilled workers and competent/trustworthy supervisory employees in service functions are also in short supply. (A good bit of these absences can be attributed to "educational" sector unions from pre-nursery through PhD programs.) These issues will not be addressed in the coming cold winter.

Long-Term, the Federal Reserve is Trapped

The favorite tactic of those in Washington is to change the rules if they are losing. Members of Congress are trying to make various economic/government financial agencies into social arbiters, including the Fed. Neither the Fed nor their supervised banks are equipped or authorized to perform these functions.

To the extent central governments want to spend a lot of others’ capital on controlling climate conditions, they will sponsor increased spending. This will result in both the Fed and the debt market increasing global debt massively. One wonders whether present low interest rates will become generational lows. Will higher rates drastically change the allocation of credit to the detriment of consumers at the low end?

Causes of Inflation

Inflation is caused by having too much money and borrowing power relative to the level of goods and services on offer. By itself it would be self-correcting through changes in price, including foreign exchange. However, when central banks create more money than their economies can immediately use, it leads to inflation. This is exactly what has been happening, so much of the current inflation has been caused by stimulus (bribes) payments. Thus, governments are a source of inflation.

Investing Choices

Perhaps the only wise reason to own securities today is the belief that the managers of some companies will be able to grow dividends above average inflation after taxes. 

If you have other reasons let us know. 

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

https://mikelipper.blogspot.com/2021/11/lessons-from-london-mistakes-repeated.html

https://mikelipper.blogspot.com/2021/11/do-you-believe-congratulations-are-in.html

https://mikelipper.blogspot.com/2021/10/mike-lippers-monday-morning-musings.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

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Four Letter Words to Sounder Investing - Weekly Blog # 678

 

Mike Lipper’s Monday Morning Musings

Four Letter Words to Sounder Investing

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

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

Debt

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

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

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

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

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

Risk

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

Rate

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

Rank

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

Time

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

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

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

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

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

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

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

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

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

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

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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

Comfort Concerns - Weekly Blog # 672

 

Mike Lipper’s Monday Morning Musings

Comfort Concerns

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

Good Numbers

This week’s US stock market performance numbers are great: Dow Jones Industrial Average (DJIA) +4.07%, NASDAQ +3.09%, and S&P 500 +2.74%. (Cannot expect to keep up this rate.) Individual investors apparently believe these bullish results can continue for at least six months. The American Association of Individual Investor’s (AAII) weekly sample survey indicates that 49.4% are bullish, up from 40.3% the week before. (Market analysts treat the AAII numbers as a contrarian indicator.)

One of the underlying supports for this bullish attitude is the average per person wealth in the US surpassing its former peak, which occurred just prior to the Coronavirus hitting. This is true, according to the Federal Reserve, even excluding the net worth of the 2100 US billionaires, who produced an average per household net worth of $330,000. (In view of these numbers, one wonders if the various stimulus measures passed, and other discussed, are going to unleash high inflation, with too many dollars chasing too few dollar-earning assets.)

By far the largest portion of the average American’s wealth is invested in financial assets (equity and fixed income), followed by real estate. A sample survey of people expected to receive stimulus checks indicates they plan to put half of it into “the market”. This appears to be particularly true of younger or inexperienced investors.

Late Stages

Often, individual and institutional investors who’ve built up their cash reserves, as many currently have, get sucked back into the market. (There is the story of Sir Isaac Newton, the famous scientist and the Master of the English Mint, who withdrew his personal assets from the market in the early stages of “The South Sea Bubble”, only to be sucked back in during the momentum move at the end, losing all his money.) Investors, recognizing the declining value of their money relative to the sharply rising value of tradable assets, often feel the need to quickly catch up and concentrate their purchases on what is moving up the fastest (momentum). 

Interpreting Fund Flows and Yield Curves

The combination of flows into both conventional mutual funds and exchange traded funds (ETFs) has been positive the past few weeks. This represents a change for mutual funds, particularly equity funds, which for many years have been in net redemptions, despite generally good absolute investment performance due to actuarial and job-related issues. 

Investors reaching retirement age often reduce their perceived risks by reducing their equity exposure. Sometimes, this switch comes earlier than expected due to an earlier than planned retirement or a business difficulties. Exchange traded fund products often attract shorter-term investors, who want to capture market volatility and some tax advantages.

The recent change in the aggregate behavior of fund buyers suggests, similar to The South Sea Bubble, that normally conservative investors feel their reserves are losing value relative to equities. This past week, investors put a net $45 billion into funds, with $29 billion going into money market funds and only $15 billion into equity funds. $1.1 billion went into tax exempt funds and $683 million went into taxable bond funds. I suspect a good bit of the money going into money market funds was transitioned from other investments.

The US Treasury yield curve tracks the difference in yield at various maturities. Interest payments are made to investors for delaying the consumption of their wealth, or for investing in more active and speculative securities. It makes sense that the longer investors delay spending their money, the more they should demand from borrowers,  often the US government. Investors traditionally need to guess how much purchasing power will be lost over the period they lend their money out. When they demand higher interest rates, particularly for extended periods, they are gauging their inflation risk. 

Today, there is a major dichotomy between what the US Government thinks long-term inflation will be, through the Fed and Treasury, and what the commercial world thinks. The US Government thinks it’s under 2%, while the JOC-ECRI Industrial Price Index year over year change is now +59.48%! Even if one discounts the index by 90% due to its volatile composition, this suggests future investors dealing with inflation rates in the region of 5%. This 2-5% spread is enough for some investors to change their asset allocations.

In searching for investments to protect against the markets being flooded with cash and materially higher inflation; it is normal to look for an investment with momentum behind it. In many ways momentum is a catch-up move to compensate for prior slow or down periods. Thus, it is not surprising that 16 of the best performing mutual funds for the week were small-cap funds, with the others tied to rising energy prices or financials expected to be flush with earnings from reserves that are too high. 

Warning!!

Four of the worst performing funds for the week were invested in the China Region. This is disturbing, as China is the single largest contributor to both global growth and world trade. The authoritarian government is actively attempting to address a growing debt expansion. While the debt is on the books of various provinces and non-bank financials, it is both a political and economic problem for the central government due to the exposure of the Chinese people. A slower growing China could be a major concern for the rest of the world.

Conclusion:

Each investor should review the concerns raised in this blog and make their own decision as to how to apply these possibilities to their multiple investment responsibilities. Please don’t ignore these possibilities completely. 

Also, if you would like to discuss, I would be happy to have a Socratic discussion with you. 

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

https://mikelipper.blogspot.com/2021/03/next-race-winner-weekly-blog-671.html

https://mikelipper.blogspot.com/2021/02/did-something-happen-last-week-weekly.html

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

Did someone forward you this blog? 

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

BIGGER RISKS THAN THE ELECTION - Weekly Blog # 653

 

Mike Lipper’s Monday Morning Musings

BIGGER RISKS THAN THE ELECTION

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

Risks should often be measured against the inverse of expectations. As our regular readers know, since the beginning of September I have warned that the stock markets have entered an emotional period where long-term investments should not be made. This is the last weekend before election day, but it is probably still at least two weeks or more before both the Electoral College and the makeup of both Houses of Congress are determined. Whatever the preliminary results, there is still a good chance of a “relief rally”. Based on past history, an extreme rally would trigger a reversal, as those politically invested in the losers reduce their exposure and prepare to sit out the next phase in a bunker, betting the winners won’t be able to deliver and will have only a short lease on the levers of power.

The Bigger Risks

I am concerned for those who address their multiple long-term investment challenges less emotionally. As an analyst and investor I am always more concerned with unexpected risks, rather than those trumped by the pundits which have already being discounted. I am also focused on material changes that impact supply and demand momentum. From this predicate I see two very different unfocused risks for most investors, the first an economic risk and the second a market risk.

Prudent Business Managers Could Have Been Wrong

Many businesspeople believe that their single most precious asset is the trust of their repeat customers, generated by the people who interact with them at the firm. I believe that all the people I’ve worked with were there to service our clients, whatever role they played. When periodic, cyclical, financial problems arose, I looked where we could try harder. However, there were times when the market was saying our costs were too high for our current volume of business. Like other businesspeople I looked again and again at where I could cut. First on the list was my compensation and last on the list was the compensation and jobs of my associates. I believe that most privately owned service-oriented businesses hold the same view. CEOs of publicly traded corporations by comparison often feel their first duty is to protect their company’s financial condition. Thus, during this pandemic and it’s period of lockdowns, publicly traded companies laid off or furloughed a higher percentage of their labor force in the early months than did private companies.

Now some deceptive good news, the level of business is recovering. Evidenced by brief quotes about factory orders from of regional Federal Reserve Banks in October:

• Philadelphia - Highest level since 1973
• Dallas -Two-year high
• Kansas City - Matches strongest since May 2018
• Richmond - Best since November 2017

While these are encouraging comments, notice how the good times appear to be coming back to the now politically favored manufacturing component of our economy. My concern is that service businesses account for over 60% of US economic activity and consequently the largest part of the workforce. I am concerned for these people who in many cases have not been able to substantially recover due to the lockdowns of their businesses. Many of the owners of these businesses were slow to cut back on the critical people that made their businesses prosper. The owners carried their people on the backs of supplied capital, some of which was borrowed or tapped from other sources of equity. For sound political and other reasons, banks have carried these loans to privately-owned, service businesses. Banks can do this because they are stuffed with too many cash deposits. (While other short-term interest rates are rising, rates paid on money market deposit accounts have continued to drop to their current average of 0.19%.)

A stimulus bill might help temporarily, but it is not a long-term solution, particularly if the retail sector is largely locked down. I have two concerns, the first being immediate cash needs. The second concern is more fundamental. Walking down many Main streets (like High Street in Britain), current shop owners cannot get their children interested in taking on the burdens of ownership. In a world of increased automation replacing expensive human labor, we cannot afford a shrinking service sector. This is not a short-term consideration.

Broad Scale Large Leverage is Dangerous

Since the beginning of transferrable money, people have been borrowing and lending with some borrowers unable to repay their debts on time. Due to low returns from banks and to some degree in their minds an insufficient rate of return on organized stock markets, individuals and institutions have turned to various credit instruments and arrangements. The current pandemic/lockdown has made it clear that most interest rates do not have sufficient room for repayment concerns. Despite this, I expect credit will rise to a dangerous point.

To keep their economies and the price of debt under control, governments and their central banks will be the first feeders of capital, although government generated money is currently not being fully absorbed by job producing uses and the excess is building. Low interest rates are currently not considered attractive enough for many in the securities markets, so they are looking to the credit markets. In effect these investors are supplying leverage to companies and individuals without sufficient concerns for defaults. 

One particular concern of mine was announced by the SEC this week, ETFs will now be able to borrow twice the amount of capital, instead of the 100% of equity capital currently available. Undoubtedly, some funds using this new facility will produce great results for some time, but not all the time. A single margin-call on an ETF could be the tinder that starts a major decline. Perhaps it’s coincidental, but this week only six of seventy-two prices tracked by The Wall Street Journal rose. These prices include stock indices, currencies, commodities, and ETFs. Also, in the week ended Thursday, the average of 7,314 US Diversified Equity Funds fell –4.16%, bringing the year-to-date gain to +1.00%. Remember, markets fall at three times the speed of rising markets, due to margin calls.

Working Conclusion: 

Sound investments should be held for the long-term. This may not be the time to find bargains.  

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

https://mikelipper.blogspot.com/2020/10/managing-mistakes-weekly-blog-652.html

https://mikelipper.blogspot.com/2020/10/momentum-is-slowing-under-too-many.html

https://mikelipper.blogspot.com/2020/10/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.

Caltech Data Heretics Go to Track for Inspiration - Weekly Blog # 632

Mike Lipper’s Monday Morning Musings

Caltech Data Heretics Go to Track for Inspiration

*Heretics are people holding opinions that are at “odds” with what is generally accepted, “odds” suggests seeking higher returns.

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

One of the luckiest occurrences of my life was being asked to join the board of Trustees at the California Institute of Technology (Caltech). Participating in board/committee meetings, as well as the informal gatherings, has been one of the great learning experiences of both my and my wife’s lives. I had not focused on the thinking process leading to the 39 Nobel Prizes awarded to Caltech scientists until this weekend. Ruth and I watched a podcast hosted by fellow trustee Rich Wolf on “The Making of The Lonely Idea”, one of several podcasts covering a few of Caltech’s scientists outlining their thinking and discoveries. On the broadcast a few realizations became clear to me:

1. Some of these great minds drew inspiration from the racetrack which is the leading source of my security analysis and investment career thinking.
2. The building blocks of our thinking rests on data, and it is often believed with religious fervor.
3. A careful analysis of the data requires a probing mindset for validation and adjustment.
4. Sound thinking must be anchored in the real world of human experience. 
5. A driving humility that accepts the reality of what is not knowable, as well as a realization of how little we individually know.

This is a particularly good weekend to focus on the investment implications of Friday’s surprising announcement of job growth in the private/commercial sectors, and a much smaller than expected rise in unemployment. The good professors at Caltech would first focus on the generation of the data that led to the burst of enthusiasm for stock prices on Friday. The enthusiasm resulted from a series of global occurrences, including China’s recovery from its shutdown and the announcement of massive US and European stimulus for their economies, to be paid largely by wealthy members for the benefit of those less fortunate.

For the purposes of this discussion I will focus on the US scene as it is the largest portion of most of our subscribers’ wealth and consumption. Nevertheless, few of us lack exposure in our investing and consumption to the influences beyond our borders. It is critical we appreciate that we are living in an incredibly fast and evolving situation as the data is flashed to us. The employment/unemployment report for “May” was for the week ended May 12th. In most months, a mid-month read is a reasonable summary glance for the entire month. However, this is not the case for this report. During May and June, the US, Europe, and Japan have been coming out of a COVID-19 lockdown. With good reason, private citizens have been reluctantly exposing themselves and their families to more contact with the outside, resulting in more people normalizing every day. Consequently, I believe the numbers for the second half of May will be materially more favorable than those of the 12th of May. With the Northeast and California coming online in June and July the employment numbers will get even better.

Humility
One of Caltech’s regular teaching lessons is that there is something to learn from every experiment, typically with more learned from those that did not deliver on their objective. (With a bunch of losing betting tickets and occasional market losses I have a reinforced need for humility.) While we never truly know what the future will hold, the breadth of today’s possible outcomes is extremely wide. In talking to people struggling to make financial plans for the fall and next year, it becomes clear that the probabilities concerning the direction of prices is currently more uncertain. Some see an initial a wave of price declines, due mostly to retail/office space rentals and the liquidation of existing finished goods inventory. This appears to be a short-term view, as almost every serious person I chat with expects prices to rise in the future. An interesting aspect of these discussions is that they initially expect the focus to be on a limited number of critical items purchased at higher prices. When asked about other prices, I am often met with “Oh, I did not think of that, but it should be added to the list”. At the end of these discussions the roster of price increases is considerably larger than the list of expected price bargains.

The key to future prices is the expected level and nature of demand. In assessing this I believe I need even more humility. The consequences of first and future waves of COVID-19, as well as geo-political considerations and habit changes, suggests that as we climb out of our foxholes people may see their lives, jobs, and homes very differently than in the past.

Financial Security
One important area of concern is the understandable desire for financial security. In our own minds we build our own fortress (prison). Until recently, many felt their jobs were the foundation of their security and this was particularly true for those who worked for large organizations. We have seen many of these employment centers “Right-sized” and many are threatened by it coming. Beyond what we earn from our labor, many count on individual and/or group investments: pensions, 401ks, 403bs, Social Security/Medicare, etc. Except for low earners, none of these are impregnable, particularly regarding high inflation. While stocks may be attractive to individual investors in the long-term, they are likely to be more volatile, with the cushions provided by floor specialists and contra-cyclical investors getting smaller. The price of gold and gold mining shares is signaling materially higher inflation. Even if the “gold bugs” are only half right, the biggest surprise to many may be the loss of purchasing power from owning “high quality” bonds.

The natural reaction to these concerns is to build ones own financial fortress, which has historically become a prison due to the lack of mobility. Stock markets in many countries are currently signaling just the opposite, with increased speculation, waves of new IPOs, and a rush into private equity, or its disguised companion private credit.

What to Do?
My investment views rests on Caltech’s practices and my track and investment experiences. Caltech’s 300 faculty and less than 2500 undergraduates, graduates, PhD, and Post Docs are always examining perceived knowledge and looking for a deeper understanding of the world as it exists. More experiments and more mistakes equal more learning, which combined with humility produces good results. Not having the breadth of Caltech, I use a twin approach. For clients and family, we build portfolios of funds, mostly equity. The portfolios use concentrated/narrowly focused funds, along with some broad-based funds. In personal accounts we occasionally add individual stocks to provide exposure to investment areas insufficiently covered in our funds. The big difference in our approach is time horizon, which when successful is for multiple generations.

Question:
Is your investment thinking evolving? If not, why not?

 

Did you miss my blog last week? Click here to read.
https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings_31.html

https://mikelipper.blogspot.com/2020/05/mike-lippers-monday-morning-musings_24.html

https://mikelipper.blogspot.com/2020/05/time-to-review-investments-weekly-blog.html



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The Temptation to Go Short

There appears to be general agreement that a bottom in the stock market indexes was achieved on or about March 9, 2009. April was a strong month, and in some cases showed the kind of progress one sees in what we used to think was a “normal" year. May, and the first few weeks in June, showed additional progress, but at a slower rate. The penultimate week in June showed some weakness. Now we have just two days to see whether we will have a trading rally for the late institutions trying to get rid of too much cash, and trading desks attempting to square their positions.

The popular press (if that term is meaningful anymore), is developing an expectation gap. Very few new jobs have been created by the government’s stimulus. Auto sales have not picked up since the intervention. Interest rates are low, which in many respects shows the lack of solid loan demand. Though somewhat counter-intuitive, many would consider moderately rising rates a plus.

Could we see another test of the recent lows? The answer is yes. But that is not the right question. The correct question is, “What are the odds that we have seen the bottom for most stocks in 2009?” My guess is that there is a better than a 75% chance that we have seen the bottom for most stocks. There is a new symbol for this bottom, “VL.” This suggests that we have already seen something of a “V” bottom coming off the March lows, to be followed by dull, relatively flat movements of most prices. (Within the horizontal portion of the “L” there is plenty of opportunity for trading successes.) Some believe this flat, range bound, market could last for a long time. One might say “VL” stands for very long.

In the face of these observations, why do I believe, in general, shorting it is now unwise for most investors? Often, the study of mutual funds provides answers to larger investment questions. The mutual fund industry is competitive always within its own market, but has grown by entering other providers’ markets; money market, tax exempts, and bank loans are just three examples. Many in the fund business feared the “retailization” of hedge funds (the decline of hedge fund minimum investment requirements) might cause mutual funds to lose customers. The counter attack by the fund industry was led by the so-called 130/30 funds. These funds invest 100% of their assets on the long side and with the use of leverage (often margin) allocate 30% on the short side. Other funds, also willing to bet on declines at least of the markets, if not civilizations, are available.

My old firm, once Lipper Analytical Services, now known as Lipper, Inc., created an investment classification called “Dedicated Short Bias Funds” as a peer group for the 130/30 and other funds betting, at least in part, on a decline. Setting up this peer group worked well. In 2008, and again in the first quarter of 2009, Dedicated Short Biased funds were the best performers (and often the only profitable funds on average) in the diversified US equity fund super-group. As I have often stated, fund performance is cyclical, driven by the highest mathematical power, within a large universe, of reversion to the mean. (Both the leaders and the laggards move in the direction of the middle of the array, often way beyond the point of becoming the new leader or laggard).

I doubt that there will be a meaningful reversal of the performance and rank of the average Dedicated Short Biased fund for the first half and second quarter of 2009. In both periods, these funds are the only classification within the U.S. Diversified Fund super group which shows negative results. Their current fund declines of over -20%, is larger than any other fund in the super group on the upside. (A number are getting close to a 20% gain for the first half.) Further, I believe it is too early to see a counter-reversal for the short sellers.

Thus my considered judgment for investors, not traders, is: this is not the time to go short.