Is There Something Happening Beyond the Discounting of Quantitative Easing?

Focus where others aren’t

I am the first to admit that many of my fellow equity securities analysts are not sufficiently aware of the bond, currency and commodities markets, but at the moment I think there is too much attention on the Federal Reserve’s expected significant purchase of US Treasuries. In the Fed’s terminology this strategy is called quantitative easing. The continuous focus on the Fed makes me recall an old baseball saying that advises players to hit the ball where there are not fielders close by. Thus far in October and most of September, the stock market has been in lock-step with the bond market. I would suggest that there are increasing opportunities to hit the ball where the fielders aren’t (buy winning stocks).

Some examples

I am intrigued with new products and businesses that have a potential of being created everyday in America. As a developer of new products myself, I have found that one of the best opportunities is to find large companies that have big problems which a new product or service can help. For the banking business, there will be no bigger public relations problem over the next several (you can supply: weeks, months, or years) than the foreclosure mess that has been created. From the public policy and publicity standpoints, the creators of securitized mortgages, mostly the banks, need to be able to quickly ascertain the legitimate title to properties that are in default and are in the foreclosure process. There have been huge numbers of paperwork errors at best or in too many cases, fraud. Currently the internal systems of banks and mortgage companies are viewed with suspicion. I have learned recently of at least two data processing-oriented companies that are seeing their order books explode. (Two of my relatives hopefully will benefit from this upsurge in their business.)

American entrepreneurs

Regular members of this blog community already know that I was given an iPad and found it so useful and, in time, essential that I bought one for my wife, Ruth. Several years ago who would have known that today we could not contemplate going on a trip without our electronic personal tablets? The genius of Apple and other American entrepreneurs is creating products and services that we did not know we needed and “can’t live without.”

I should not focus on the American entrepreneur without the recognition that it is the American marketplace that can buy new products and services in quantity. In an age where the US is seeing the number of its new car brands shrink, we have at least one new automobile company, Tesla. Though initially these few cars will be produced in the US, much of the capital and technology came from overseas.

Implications for ultra high net worth investors

What does this mean to the ultra high net worth investor?

First, good investors recognize that the import of the headlines, both in print or spoken by the “talking heads,” is already being evaluated or discounted in today’s securities prices.

Second, one should look for investment ideas in the shopping malls and the back pages of focused periodicals. These periodicals can be financial, but more likely are trade or scientific journals.

Third, many of the fortunes of ultra high net worth people came from a single-minded focus on markets and products that others did not see. While I have a bias looking for technological advances, over this weekend I learned of a very successful businessman who made his money in something as prosaic as ironing board covers. To do this he had to solve product, distribution and capital problems. In many ways his “formula” was not a great deal different than that of Apple or Tesla.

Fourth, every day there are opportunities for the intelligent and patient investor to make money.

Please share with me some of your successes.

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To Members of Mike Lipper's Blog Community:

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Governments Join the Bond Bashers

(Warning: this blog is both argumentative and complex. You may find little that you will accept)

The Preamble

I challenge you to find the single most powerful political drive in the constitution of the US or any other government. Whether democracies, pseudo-democracies, or controlled states, the governing group is leased the franchise by the governed as long as they put bread on the table. The lesson that has crept out of the years of the welfare state and other socialistic approaches is that the central government is not very good at putting bread on all of the tables. Due to inefficiency and corruption, governments are not good engines of employment. Military contracts, road building and other grants as pump primers haven’t worked effectively for at least ten years. What is a politically savvy government to do in this post-industrial state? In many countries unemployment and under-employment is much too high for those in power. Complicating their problem, the current size of aggregate demand is not sufficient to foster hiring.

The Political Solution

Apparently the governing élites believe that the size of the existing demand in units of work is currently fixed. The way to increase the economic power of the existing demand is to raise prices. They believe higher prices will lead to more jobs rather than higher prices will lead to less demand. Raising taxes has little positive effect for employment. However, if prices go up the unsophisticated businessman and many securities analysts will see nominal profits rising. Rising profits will encourage employment and investment, or so the theory goes. The problem for the political powers is how to get prices up with slack demand. The way to do it is to raise costs, which on the surface level can be accomplished by increases in taxes and user fees. Politically there is a risk in this strategy. There is a better way which apparently has less political risk and is not as obvious.

The Better Way

If the governments, not just the US, can import inflation, costs will rise and nominal profits may as well. Inflation is being imported from that very powerful engine of inflation – China, as well as that sometime inflation factor, energy prices. The mercantilist recipe for a nation in economic difficulties was to devalue the stated value of its currency compared with its trading “partners.” (This is a game many Wall Street Partnerships also learned.) With the creation of both “the single currency” (the euro), and the de facto single reserve currency (the dollar), an exchange rate currency war would be difficult to win. However, if a currency’s value is depressed by the recognition that its purchasing power is declining, currency exchange rates will respond. The impact of lower effective rates is that export prices are lowered and import prices rise, which helps the balance of payments. As the US and now the EU are attempting to push the yuan higher with limited success, the US currency is dropping in value against almost all major currencies.

The Talking Heads

One of the age old beliefs in Wall Street is the odd-lotter’s theory that the public investor is always wrong at turning points. Careful statistical analysis of the data does not support a strong conclusion to this effect. Nevertheless, one of the favorite approaches of market commentators is to divide the world of investors between sophisticated investors and the “hoi polloi,” or the common investor. They view the net outflows from equity funds and net inflows into long term bond funds as a classic odd-lot signal to buy stocks and sell bonds. As with most sound bite views, the background analysis is not so one-sided and therefore is open to further interpretation. While there are a fair number of individual active traders, there are a decreasing number of active individual investors trading these days in their own accounts. Many use their salary savings plans (401k, 403b, and 457 plans) for their structural investing. Mutual funds have become the most visible arena of individual investors and this needs to be studied to understand what people are doing with their money.

Reading the Mutual Fund Tea Leaves

The net flow data on the purchases and sales of mutual fund shares do not tell the mis-asset allocation story that the talking heads believe. I believe that there is a decline in the gross sales of equity funds. Many of the funds’ good to great performance records were destroyed coming out of 2008, and for the most part their recoveries have not reached their 2007 peaks. Thus many minds believe there is no immediate incentive to invest in perceived riskier equity assets now. Further, many of those in the their middle ages who are the traditional fund buyers are worried about their jobs. On the redemption side of the equity funds, I believe that most redemptions are, in effect, completion payments for retirements or to a lesser extent, educational expenses. Retirements for many came earlier than expected and there was a need to husband remaining assets when income disappeared. Perhaps more misleading to some was what was happening on the fixed income side of the flow data. Many observers recognized that the $2 to 3 trillion in money market funds was largely cash reserves that used to sit in bank deposit accounts awaiting future expenditures. They focus on all of the rest of the taxable fixed income funds, which currently total more than US$1.9 trillion.

What really happened was that a significant minority of money market fund holders grew tired of earning practically nothing on their reserves and moved some of their money to Short/Intermediate Bond funds of various credit qualities. These funds now represent over $1 trillion on their own or over half the $1.9 trillion in the non-money market taxable mutual funds. Over the last twelve months they have earned 2.64% to 9.43% on average, depending upon credit and interest risk they have assumed. I believe that at least half of these dollars will return to the equity market when there is forward momentum in stocks.

Another disguised equity component in the fixed income mutual fund field is the group that has the most money in long term bond funds. High Yield funds currently have over $176 billion in assets. When setting up the original Lipper Analytical Services Fixed Income Fund Performance Analysis report as a companion piece to the equity report, I was tempted to put High Yield funds in the equity report. At the time, as a student of Graham and Dodd I viewed them as essentially stocks with coupons. If one traces out the performance history of these funds, one will find they move with the stock market. When the stock market is moving up there is a better chance to refinance expiring low to mid quality bonds. Also more “junk bonds” are created in equity-like deals in a bull market. My friends in the distressed securities funds are salivating at the huge number of low quality bonds that are maturing in the next few years. If we remain in a flat economy with some induced inflation, a number of these issuers will not be able to refinance their debt and will become candidates for the distressed securities buyers.

The Evidence of Inflation

Central governments in conjunction with most central banks appear at the moment to be winning the currency wars through inflation. Clearly the rise in the price of gold is attracting more buyers. But compared with the size of the gold market, the size of the market for US Treasuries is much, much larger. One of the measures that I use in determining the expected magnitude of inflation over the next ten years is the break even ratio between 10 year Treasuries and 10 year TIPS (Treasury Inflation Protected Securities). In August, TIPS were yielding 1.51% less than similar treasuries. Currently the spread is about 1.98%. Knowledgeable buyers are paying an increasing insurance premium on inflation.

What to Do?

For those accounts that must carry reserves, we have been shifting money into Ultra Short obligation funds that invest in very high quality paper with average duration less than a year and a maximum maturity of two years. For some accounts we have added Australian and Canadian dollar short term investments and even some foreign currency Certificates of Deposit.

What are you doing?

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To Members of Mike Lipper's Blog Community:

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Manager Selection in a World With Uncertain Forward-Looking Statements

The Sleeping Pill

One potential cure for the sleep deprived and a somewhat required reading for serious analysts is reading the SEC Form 10-Q of companies of interest. This is a disclosure document that details the past quarter and other periods of a publicly traded company. To make the document more useful to shareholders and/or perspective investors, the SEC requires a section called “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” This narrative gives the management a chance to explain in words what the numbers show or do not show. In order to dampen too much reliance on what is printed, there is a required additional (actually very long) statement entitled “Factors which could cause changes in the expectations or assumptions on which forward-looking statements are based include, but are not limited to.” At every investor meeting or analyst conference call reference is made to this disclosure.

Perhaps I read these turgid documents to repent for my sins as an avid follower of the mutual fund industry and a portfolio manager of a small private financial services fund.

The Nightmares

State Street Corporation is at the center of the mutual fund universe as the largest fund custodian in the world, the second largest manager of exchange traded funds (ETFs), a major provider of passive portfolio management and other services. With its impressive client base it should have a good view of the future for the investment business as well as itself. However, it lists 22 separate bullet points under its “Cautions as to Forward-Looking Statements.” In my opinion, 15 of these points are importantly under State Street’s control or at least heavily influenced by the bank. The seven that are not under State Street’s control or influence raise concerns as to the predictability of the future. I will briefly summarize them below:

1. The financial health (viability) of its counterparties as impacted by changes of law or regulation.
   
   
2. Financial market or economic disruption beyond “normal.” (To some this may be the “Black Swan” or “Fat Tail” risks.)
   
   
3. Not only the maintenance of high credit ratings, but also the level of credibility of credit agency ratings. (I believe a world without some informed credit ratings is a scary concern for all. Our fund is a long term holder of Moody’s stock.)
   
   
4. The level of redemptions and withdrawals from State Street’s collateral pools and other collective products.
   
   
5. The potential for new products and services that could cause the bank to be at operational risk and exposed to higher unreimbursed expenses.
   
   
6. Changes in accounting standards and practices. As we attempt to have a single global set of accounting standards, the accommodations to foreign issuers could cause harmful results to domestic issuers.
   
   
7. Changes in tax legislation, the interpretation of existing tax laws and the affect as to when tax payments are due.
   

The Implications

Perhaps it is very strange for me, who made money by analyzing and selling past fund performance data, to now consider State Street’s precaution that the past is even a worse guide to the future than it was in the past. The conservative management of State Street is suggesting that we should be warned that we are entering a new investment world. What this means to me is that reliance on past historic patterns could be dangerous to our wealth. Carrying this thought out, we should question the utility of various individual securities indexes like the multiple Dow Jones, Russell and Standard & Poor’s benchmarks. By definition many ETFs can become suspect of not capturing the new forces that operate within the markets.

The Exploiters

Many portfolio managers spend their entire investment life investing in the same securities. Some of these have good long term records, but that may not be of much comfort going forward if the pace of disruption accelerates. I would suggest that early general stock market investors who purchased Apple (which I own personally by historic accident) and Google after the flipping of the IPO phase ended, recognized change. Similarly, those global or international funds that were early in China showed the kind of sensitivity needed to ride the future waves.

How do you find these managers? I would suggest that it will be worthwhile to look at the new purchases shown in the interim reports. New names to the portfolio and perhaps new names for you are of great interest. Of course they have to go up in time to be very valuable. However, the willingness to buy into the unfamiliar can be a good trait, if on balance it leads to success.

A Search for New Names

If members of this blog community wish to suggest new names to me, I will be happy to publish a list with or without attribution and further comment in a future issue of this blog.


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To Members of Mike Lipper's Blog Community:

For readers who would like to stay current on my uncommon perspectives regarding investing and world markets, join the community by subscribing, at no monetary cost, just your time and interest as well as occasional responses. Simply click the "To Receive Blog via Email" box on the left-side of the screen.

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Emerging Market Warnings, Crowds Ahead, Smaller Exit Portals

Ever since the dawn of attention to investment performance, the smart guys figured the way to outperform was to invest outside the general experience of others. Often this technique worked initially until too many others copied the strategy. As with life in general, the unexpected happened and the exits became crowded and were blocked for the late movers. This is a repeat performance of a movie I have seen before.

I am a Believer

I am a believer in investing internationally. As a trainee in my first job after my education in the US Marine Corps, I had a tour of duty within a bank’s vault to count the actual foreign stock certificates that backed up the bank’s issuance of American Depositary Receipts (ADRs). More than 15 years later, when I could start to invest for my own account, I began investing outside of the US. Over the years I have invested in Latin American and Asian closed-end funds, individual equities in Canada, Australia, the United Kingdom, Netherlands, Finland and Japan as well as private equities in the UK and France. In addition, at the time of my sale of the operating assets of Lipper Analytical to Reuters PLC, we had foreign clients buying non US-data from our offices in London and Hong Kong. Thus, I believe I have won my stars as an international investor. So why am I raising the yellow flag of caution now? Simply because it is getting crowded out there.

Petrobras

On Thursday of this last week Petróleo Brasileiro S.A. or Petrobras, sold over $70 billion worth of common stock. This was the world’s largest initial public offering (IPO). According to the Wall Street Journal, options will be available which will expand the common stock offering by 25%, including an undisclosed amount of preferred stock. (It is true that some $43 billion was an exchange with the Brazilian government for the drilling privileges to a potentially huge offshore series of sites. Nevertheless, an enormous amount of cash was invested into Petrobras.)

First Warning Flag

The sheer size of the enthusiasm for this transaction should be enough of a warning to a practiced investor, but there are other danger signs. Petrobras has been a favorite of many well-known global investors. A number of them felt that the terms of this offering were not in favor of the existing outside shareholders but were to the benefit of the government. Among those who are rumored to have sold out are George Soros and the good people at Templeton. One of the risks in any investment is that the government may turn less friendly. (This risk is valid in the US as well.) Based on my experience, foreign investors typically don’t really own foreign securities permanently. They rent them.

The Second Warning Flag

One of the better international money managers that I had the pleasure of knowing taught me the importance of the flows of money into a security. In the 1970’s, he focused on foreign money coming into the Japanese markets. He believed that the “weight of money” would lift Japanese stock prices that were clearly not bargains. He focused a good bit of his attention on mutual fund data and that was why he contacted me. His clue to exit an overpriced market was when there was a slow down in the gusher of money coming into the market.

As is commonly acknowledged, mutual fund redemptions have been larger than the rather lackluster sales of US Equity mutual funds. As of the end of August, according to my old firm now called Lipper, total net assets are approximately $4.7 trillion dollars, with only $3 trillion devoted to US diversified investing. The fifth largest collection of assets is in Emerging Market Equity funds ($253 billion). This excludes $112 billion of the more narrowly focused funds that invest outside of the US and Europe. The two collections together have total net assets of $365 billion as of the end of August, which is somewhat larger than the money invested in S&P 500 Index funds. Clearly, emerging markets are not undiscovered territory. The cautionary flags go up with US Diversified Equity funds shedding $ 10 billion in August, with $2.3 billion going in one month to Emerging Market funds. This shows a significant shift in investors’ opinion. A more dramatic indication is that in the same month $3.8 billion went into Emerging Market exchange traded funds (ETFs). I believe this latter inflow is much more speculative in nature. If you will, they are more like daily renters than annual leasers.

The growth in demand of ETFs is particularly ominous. Money can flow in and out of these funds on a daily basis. When the money moves, the managers must transact as nearly as possible to mirror an individual stock’s proportional ownership in the index. If some negative news event causes a redemption run on an ETF, they will have to sell some of each position. The history of international investing, particularly in small markets, is that when we come in we buy from the locals who feel that our valuations are wrong. When we sell under duress they understand that any price is a good price from the pressured seller’s point of view. The losses can be dramatic under those circumstances.

To put the ETF risk in perspective, each week I look at the twenty-five largest SEC registered open-end funds. On that list are five ETFs, two of which invest in emerging markets. On a combined basis these two funds have $70 billion in assets. They promise their large shareholders instant liquidity during US trading hours.

The Third Warning Flag

The next set of concerns is one of personal exposure. Over the last two weeks I have had three discussions about emerging markets. The first was with a marketing executive of a major broad line fund group who was commenting that its International/Emerging Market funds were selling very well. The second conversation was with a retired international investor who was being pitched to go back in business, focusing on the frontier markets which are exciting many people. I am hearing a great deal about investing in Nigeria and Ghana. (Memories of the “South Sea Bubble” of the 18th Century come to mind.) The final conversation was with a fund president who has been away from the market for some time and is being asked to develop a country-specific infrastructure fund as well as other frontier investments. (The Nineteenth and early Twentieth century investments by the Scottish trusts and Barings also come to mind.)

Warning

Despite HSBC’s ten point pitch to invest in the emerging markets and Western Asset’s belief in the attractiveness of the debt side of the emerging markets, I would be particularly careful now. If you are lucky enough to have been there already, cap your exposure at sometime. If you are not invested in emerging markets directly, you can gain some exposure through US companies that export or have operations in the area. As a contrarian bet I would look to large US Growth funds, they have lots of attractive companies in their portfolios at reasonable prices. They should do well enough on a relative basis over the next four years.

What do you think?
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To Members of Mike Lipper's Blog Community:

For readers who would like to stay current on my uncommon perspectives regarding investing and world markets, join the community by subscribing, at no monetary cost, just your time and interest as well as occasional responses. Simply click the "To Receive Blog via Email" box on the left-side of the screen.

For those already receiving my blog by email, if you would like to recommend this blog to a relative, friend or colleague, the sign-up is located on the left-hand portion of the screen at www.MikeLipper.blogspot.com.

How to Recognize Risks Before They Bite

While no one rings the attention-getting bell at the peak or bottom of a market, there are often plenty of warning signs. The biggest sign is growing enthusiasm for whatever is the current trend. I perceive that there are some flashing yellow signs suggesting that there may be problems ahead, both for me personally and for some portfolios that are my responsibility.

Previous “Rules” Based on a Different Economy

Last week in the second of a two part blog post, I gave the impression that the next major move is up. Like most people that choose to get out of bed in the morning, I am gambling that things will be good for me that day, if not beyond. To balance this bullish point of view I should recognize that there are a number of structural problems which may put the timing of the expansion in question. The first is the liquidity risk which brought down Bear Stearns and Lehman Brothers, as well as most people facing foreclosure. At the end of their day they did not have the cash to meet the immediate call on their assets. Most personal financial consultants initially urge individuals to have at least one month’s expenses in the bank. By early middle age the pot should be three months, and later one year. All of those ratios were essentially based on the historic experience that a young person could find a job in a month. By age thirty it might take three months and by fifty a year. In a corporate context, for many years the IRS threatened various companies which amassed a lot of cash with a possible surcharge if they did not pay out dividends or use their cash. All of these “school solutions” were based on a different economy than what we have been in for sometime. With at least one quarter of the unemployed and underemployed without a full time paycheck for at least two years, a reasonable contingency fund probably should be built up to a two year level of reduced expenses. In addition, companies have to determine how long they can keep their doors open and maintain critical employee skills in an extended period of an economic slump.

Voluntary and Involuntary Savings Rates

In reaction to these present realities, private sector savings rates have moved up. This is not as positive a sign as we would like to believe. The growth in savings has largely been a function of paying down debt. Actually in most cases the pay downs were involuntary and accomplished through foreclosures or bankruptcies. One should watch bank deposits as well as mutual fund gross sales to spot voluntary saving. What makes the situation worse is that a decline in private sector borrowing is totally offset by expanded government borrowing for low return investments.

A Bull Market, When?

The reason to watch bank deposits and mutual fund gross sales is to begin to gauge the liquidity preference of the population. I suspect that as a reaction to the aforementioned rules of thumb proving to be inadequate, that consumer reserve levels will rise above historic levels. As long as the money isn’t put under the mattress it will be in the hands of various financial services intermediaries who hopefully will make high quality loans to any who wish to accept their own liquidity risk. Only when the public either directly or through 401(k) and similar vehicles invests in equities, will we seeing a rip-roaring bull market. (Note I said when, not if.)

Replacing Structural Underemployment

Another burden that our society has to carry is the weight of the structurally unemployed or underemployed. Many of the jobs of old have been permanently replaced by automated technology. My faith is that technology will enable new products that will provide employment. An example may help. In a bout of the new form of conspicuous consumption, I recently bought Ruth an iPad to match mine. The wonderfully helpful sales person at the Apple store was a former mid to high level executive from a tech company. In her sales pitch (which we had to wait for), she said that Ruth now had the “single most sought-after item in the world today.” While this is a bit of hyperbole, the hyped demand did fill one of the bigger stores in the Mall. We learned that if we wanted help from Apple’s “Genius Bar,” in other words their help desk, we needed to make an appointment by phone or email. Hundreds of thousands of new applications for this and other consumer gadgets are now available to support these items. I am sure that we will see consultants and teachers putting out their shingles to be of help.

Another example is the advent of hybrid cars and particularly trucks, creating needs for different kinds of mechanics and service stations. Gradually I hope we will whittle away the structurally unemployed, but as a society we need to come up with a productive and humane answer for the structural underemployment. Without an effective solution, there will be much more risk.

Until these economic problems are successfully addressed we will be operating significantly under capacity utilization. While these challenges may retard a demand driven inflation, it suggests that we won’t see historically high market valuations soon.

What all of the above is suggesting is that my bullishness could be premature. What do you think?

Next week I intend to write on the risks to fixed income investors and the possible misplaced enthusiasm for emerging and frontier investing.

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To Members of Mike Lipper's Blog Community:

For readers who would like to stay current on my uncommon perspectives regarding investing and world markets, join the community by subscribing, at no monetary cost, just your time and interest as well as occasional responses. Simply click the "To Receive Blog via Email" box on the left-side of the screen.

For those already receiving my blog by email, if you would like to recommend this blog to a relative, friend or colleague, the sign-up is located on the left-hand portion of the screen at www.MikeLipper.blogspot.com.

A Contrarian’s Long-Term Outlook

In last week’s blog I described the market measures and representative sectors that comprise the foundation for my long-term outlook. My contrarianism is in contrast to many analysts and pundits, though I am sobered by the fact that of the 90 stocks I track every day, only 7 were up for the five-year period.

Recovery, or More of the Same? Why?

A knowledgeable reader emailed me to ask why I believe a recovery may be in the making. Because there has always been a recovery is not a sufficient foundation for me. In part because of my exposure to Caltech and a background of examining various funds seeking good investments, I am optimistic. Similar to the New York Yankees solving their business problems (as I mentioned last week), the American society comes up with solutions to many of its problems. Some of the products and services that we produce will not only address our problems but will also be in demand beyond our borders. The iPad, Boeing Aircraft (to economically replace aging plane fleets), Deal Making (we lead the world in those skills), wheat( in a period of growing excess demand), social media (Facebook, etc), US movies and televisions shows (with greater international revenues than domestic) and new drugs and other life-altering medical devices. I will be the first to admit that these products and services, with rare exception, are not massively labor intensive. But they are factors that may help us. For example, the vast majority of immigrants (legal or otherwise) come here to make money. They are strivers and in the long term may be more productive than many of our other residents.

In the future some of our military dollars may be shifted to much needed infrastructure expenditure. In the long run I am confident that we will continue to be a nation of problem solvers.

Four Low Hurdles Before the Outlook

There are four brief periods that we will pass through before most investors will be comfortable enough to look at the long term future. Each of these periods is likely to produce higher than normal volatility as the headlines will scare us one way or another depending on our own biases. The first is the period between now and the general election when the control of Congress, particularly the House of Representatives, will be determined. The next and to me the most worrisome, is the post-election session. A significant number of the members in both Houses will be incumbents who will not likely face voters again. These people are prime candidates for government appointments or key lobbying positions. Watching this sausage machine won’t be pretty. The third period will begin with the new Congress, when there will be jockeying for various committee assignments and chairmanships. Not all of these will be in favor of pro-investment legislation. The final period will be after the President’s budget message. That message will give the Congress the choice of bargaining with the White House or just ignoring the Administration’s wishes. There is likely to be some progress, but the execution of the legislation will still leave a lot to be desired in terms of logical clarity.

Contrarian Outlooks for the Long Term

1. The S&P 500 will likely gain at least 200% (JP Morgan points out that historically when a market recovery takes place, gains of 250% can be expected.
   
   
2. The S&P 500 is likely to somewhat outperform most managers, unlike what it has done over the last ten years.
   
   
3. One would be better off betting on the lagging groups, particularly the Science & Technology funds than the Emerging Markets and Resource focused funds. The real winners are likely to be the companies that use technology to disrupt the ways others do business.
   
   
4. For some time bond yields will rise with the stock market
   
   
5. The US will not default on our debts, our assets are too valuable.
   
   
6. The lost generation of investors will return to the marketplace.
   
   
7. At a low enough price level, the housing market will recover. Often prices will reflect intelligent replacement costs.
   

Bottom Line

Our stock market has not been capital productive for ten years. Is this a long enough period of base building to support a market expansion? That depends on whether one sees the ten years as a correction and correction for what. If we are correcting primarily for too high equity valuation, we probably have already done that. Well covered yields on many stocks are now higher than Treasury bonds. If we are correcting from an overvalued currency, that has been happening in fits and starts at least for 20 years. What we have not corrected for is lending practices at the consumer, business and governmental levels. The current approach of just requiring more capital to cushion the bad loans does not irradiate the bad loans, as a matter of fact it probably causes more risky loans, as they produce more profits than safer loans, (the potential profits are greater than the additional capital requirements). We still have the need to correct for the bad loan policies and this could delay our recovery. Another correction we may have to make is that of our use of inflation. Governments have been users of inflation to reduce the purchasing power of their debt repayments. Businesses, when faced with assured but flat demand have often elected to raise prices to increase revenues rather lower prices to increase demand. If we need to correct for our inflation biases, it may take along time. For most of our lives we have lived in an inflating society. Any correction may have to represent something on the order of 1/3rd to 1/2 a normal lifetime. I do not know which correction phase we are in. My guess: for a significant portion of your money, you should invest in the future; it will be better than not over the next ten years.

One clue as to whether the correction phase is ending and the next expansion is beginning, is to look to the mutual funds that are characterized as large cap growth funds. With rare exception it has been very difficult for large capitalization growth companies to make significant progress. While there have been some exceptions (for example Apple and Google), to date there have not been a minimum of twenty of these to drive a reasonably sized growth fund portfolio forward. As a contrarian I would suggest a minor investment in this category might alert you when such a move may begin.

The turn could be sooner than we think. On a rainy Sunday with the New York Giants playing locally, the Short Hills Mall was full of people with shopping bags. These were adults not participating in back to school shopping.

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Reluctantly Preparing a Ten Year Market Outlook

The Yankees Win !!!!

Last week I broke one of the practical rules of blogging and will again this week. I promised last week I would discuss my market outlook in this post. One should never promise anything that you don’t believe you can easily deliver. While I had some preliminary thoughts, I certainly did not have a well thought out view. As often happens in life, I got bailed out by unexpected events. Tuesday morning Ruth and I were offered the use of two corporate seats for that afternoon at the new Yankee Stadium. Though it was approximately twenty years since the last time we went to a baseball game in the Bronx, we leapt at the chance to see the new stadium for ourselves after hearing so many favorable comments. Many years ago I discreetly became a Yankee fan after the Giants deserted New York. I should have been a Yankee fan, as professionally I believe the weight (power) of money more often than not wins. We had a good time and the Yankees won with their “patented” home run attack in a shut out.

The Problem Solvers

The Yankee organization, the City of New York, and the stadium’s bond holders had to solve a number of problems to make our visit a success. In the recent past for many of us occasional arm chair types, watching on television seemed better than fighting a large unruly crowd. Frankly, in many respects, it was a boring event to watch compared with our client, the National Football League/Players Association games. For many years in the 1980’s and early 1990’s the Yankees did not seem to be able to win when it counted, at least the American League championship if not the World Series. After all, this is New York.

The new stadium did not have any pillars blocking a clear view of the entire field. There were very large and smaller television screens spread throughout the stadium. These screens, aided by the public address announcer and various musical calls, led the crowd in cheers. NYPD’s finest, plus private security people were evident in the stadium as well as the parking areas and exit roads. Bottom line: the management of the Yankees solved many of the old problems that reduced the size of their gate. They were creative investors solving their problems. At this point, the bond holders do not have much to fear relative to their other holdings.

The significance of the Yankees solving their gate issues shows a typical American approach: we do solve problems, and therefore I believe we will solve the current problem of stock prices.

The Inputs to a 10 Year View:

The Market Measures

As many of our blog community members know, if you cut into an analyst a historian will bleed. So as they say on television, “Let’s go to the replay.” From 1839 through 2009 there were only four out of seventeen rolling ten year calendar periods when the stock market averages produced a zero or worse return. In terms of individual years, the count is nine out of seventy years. For the ten years ending this August, the S&P500 was down -1.81% on a compound basis. (The average S&P500 fund was off -2.30% and the average of the thirty largest of these funds showed a loss of -2.05%, exemplifying the additional costs of indexing.)

The Sectors

Over the same 10 year period, eleven out of the twenty US Diversified Equity fund averages were positive and two others declined less than the S&P 500. One of the better ways to characterize a period is to look at the leading and lagging sector funds. The double digit leaders on a compound growth rate basis were the Gold funds +22.24%, Latin American funds +15.12%, Global Natural Resource funds +10.91% and the Emerging Market (equity) funds +10.66%. There were only two double digit losing group averages over the ten year period, the Telecomm funds -10.41% and the Science & Technology funds -10.17%.

The Five Year Picture

I track the prices of ninety common stocks every day the US stock market is open. Most of these are financials and many are in a private hedge fund that I manage. Only seven of these stocks are up over the last five years.

How Bad is the Economic Picture?

Often one can get a better view of us through the eyes of others. The International Monetary Fund (IMF) has completed a formal study as to the odds that the US will default on its foreign debt sometime in the future. That they would even consider such an occurrence should shake some people up. What is perhaps worse is they put the odds at 50% of a default.

A Lost Generation of Investors

One of the great advantages that my generation had when we entered Wall Street was that there were very few people who were senior to us in age. Those that were older were within five years of retirement. Many of them were unequipped to handle the robust markets of the late fifties and early sixties. Under normal circumstances, the missing middle management would have come from the lost generation of investors who either lived through or were frightened by the Great Depression. Their fears would not allow them to look at the great values that we found. The values we found were augmented by unique career opportunities to advance within the investment structures.

Today many individuals can not completely withdraw from the ravages of fluctuating prices, as the bulk of their retirement money are tied up in 401(k) or similar plans. Further, the current level of interest rates does not provide an adequate return for building their retirement nest egg.

These are my inputs to a long term outlook. Due to the length of these thoughts, I will continue with the specifics of my ten year outlook next week.


____________________________________________
To Members of Mike Lipper's Blog Community:

For readers who would like to stay current on my uncommon perspectives regarding investing and world markets, join the community by subscribing, at no monetary cost, just your time and interest as well as occasional responses. Simply click the "To Receive Blog via Email" box on the left-side of the screen.

For those already receiving my blog by email, if you would like to recommend this blog to a relative, friend or colleague, the sign-up is located on the left-hand portion of the screen at www.MikeLipper.blogspot.com.