Inconclusive, But Trending Lower - Weekly Blog # 733

                                    

Mike Lipper’s Monday Morning Musings

Inconclusive, But Trending Lower

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

We Want Clarity

In truth, we don’t know what the future holds for us, our families, country, world, and oh yes, our investments. In terms of the US stock market, we are searching for a sign or a group of signs giving us the courage to act, hopefully before others. I am an optimist and a contrarian, based not on personality, but arithmetic. Markets spend most of their time trending on average in one direction or the other after turning points emerge. Those of us who find bull markets more pleasant and profitable than bear markets are in search of a turning-point. We have been conditioned to at least anticipate the end of a directional move before a major reversal to a new one. This makes sense because turning points occur when there is a dramatic difference between buyers and sellers in their transaction volumes When this happens an emotional low or high point is reached, although an actual low or high often happens on a different day with materially less volume. Historically, lows and highs are tested at least once, if not multiple times, without establishing new highs and lows. This week was not such a turning point in my opinion.

The Week Ended Friday the 13th of May

On the New York Stock Exchange (NYSE), 47% of the stock listed reached a new low. Similarly on NASDAQ, 49% reached a new low. Perhaps more convincingly, the volume of declining prices was about twice that of rising prices on the NYSE (16.6 million vs 7.9 million); whereas on the NASDAQ it was about three times (15.0 million vs 5.1 million). The plurality of the selling was more dramatic than the indices dominated by large caps. (Dow Jones Industrial Average (DJIA) -6.36%, S&P 500 -2.41%, and NASDAQ Composite -2.8%). Perhaps the relative performance of mutual funds reflects the extremes of fund shareholders’ fears. The best performing large sector was US Treasury Funds, with the weakest being Precious Metals Funds.

Intermediate-Term Outlook

Prices, interest rates, and yields reflect participant feelings about current levels and their impact on future results. The Producer Price Index (PPI) read +15.68%, the JOC Industrial Price Index +9.47% (already starting to fall), the Consumer Price Index (CPI) +8.24%, Inflation 4.21%, and the Broker Call Loan rate 2.75%. What could be more indicative are fund flows into Chinese domestic funds, which almost doubled this last quarter from their 2nd quarter in 2021 (816 billion RMB vs. 456 billion RMB).  

Other concerns include the S&P 500 declining for the first four months of the year, as most of the time the remaining 8 months cannot break even for the year. For some time market capitalization has provided a good clue to stock price performance, presumably because the large-caps are more liquid. However, when analyzing fund performance by market capitalization this week, there does not appear to be any appreciable difference in year-to-date performance.

Longer-Term Concerns

Secretary Yellen is pushing a minimum global corporate tax, part of the redistribution effort in the US and an effort to destroy sovereignty. Our contacts in Washington suggest these proposals will have difficulty passing the US Senate. The mere fact that it is being proposed generates a market and economic negative that worries some.

Initial Thoughts About the New Bull Market

As usual, I am premature in thinking about the future. Because it takes me a long time to research and make up my mind, I need all the time and help I can get from subscribers and others. Below are a few briefs of my thoughts, which I hope will spark a response.

• Service companies look to be better than goods companies due to the limited amount of talent available. This will lead to favorable pricing.
• Invest in countries and people that are honest, save, and are believers in a practical education.
• Invest in technology that uses new ways to solve problems.

Please share your thoughts now, even though we probably have considerable time before the new bull market comes. The new bull market will probably be led by other names than the old.

 

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

https://mikelipper.blogspot.com/2022/05/havent-found-bottom-yet-investments.html

https://mikelipper.blogspot.com/2022/05/three-worries-april-near-term-slowdown.html

https://mikelipper.blogspot.com/2022/04/short-long-term-thoughts-weekly-blog-729.html

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A. Michael Lipper, CFA

All rights reserved.

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Haven’t Found Bottom Yet! Investments & Military Win by Committing Reserves Successfully - Weekly Blog # 732

 

                                

Mike Lipper’s Monday Morning Musings

 

Haven’t Found Bottom Yet!

Investments & Military Win by

Committing Reserves Successfully

 

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

Investment Success Defined 

Avoiding losses and participating in “bull markets” is the objective of my blog. To accomplish this goal, one needs to expect some losses. However, the key is to not lose too much capital, so gains are multiplied. The strategy I use builds up reserves when the prices of what my clients and I own are high compared to perceived general market risks. I allow capital reserves to build up to the point of meeting conservative cash expenditure expectations, plus a trading reserve for future investment. Years ago, insurance companies set up “valuation reserves” to capture gains above 20% to use for the next upswing. Inherent in this strategy is the assumption that there will be periodic down markets. The trick to making this a successful strategy is the proper timing and approach to committing reserves. 

 

Committing Reserves 

This is the single most difficult task, both for an investor and military leader. In each case the reserve can be wasted by committing too early, and that is why it is often committed piecemeal. For an investor it is important to identify a time and price soon before a price rise, whereas for the military it is near the point of exhaustion of the enemy’s supply chain. It is for this reason a market’s reaction to current events becomes much more important.

 

Why No Bottom Last Week 

 In theory, I should be calling a bottom for last week. We had a relief rally on Wednesday after the Fed publicly acknowledged inflation was more than transitory and committed to successfully addressing it. The next day, led by “growth stocks”, the market wiped out considerably more than the prior day’s gains, with further losses the final day of the week. 

Historically, the price level for the stock market occurs either before or after the high-volume day, when sellers feel compelled to liquidate at any price. We did not see this happen last week. I noticed at least three inputs that questions the longer-term outlook for stocks. 

 

“3 Strikes and You’re Out” 

This is what the baseball umpire yells when a batter misses the pitched ball three times. Perhaps that was the proper call for the week, with the three strikes against the Fed being their attempt to hit the inflation ball out of the park. However, they failed to see the very fast pitch delivered by the seasonally adjusted money supply. M2 grew 12.11% year-over-year, even after considering the current rate increase and three additional anticipated 50 basis point increases to 2.5%. This may be all the politically diseased Fed can do as it ignores the major cause of inflation, the stimulus (bribes) fed to the economy by the White House over the last two administrations. (I don’t know how much of the Russia-Ukraine war expenditures are in the current M2 numbers). 

Immediately following the rate rise, the major banks raised their prime rate to 4%. Remember, in theory the prime rate is reserved for the bank’s best credits and does not include much of a loss reserve. Currently, most banks are overflowing with deposits and a lack of good loans. Most commercial bank stock prices are also languishing based on their near-term outlook. If major banks require 4% on almost riskless loans, what should the investing and depositing public require from other financial institutions in the way of yield? This is the second strike against the market and the Fed. 

 The third and final strike is a curve ball ordered by the FTC and SEC. The regulatory mandates they extended way beyond prior policy practices.  If this expansion is permitted, public companies will expand less and many private companies will never be traded on US stock markets. 

To demonstrate how much the reach of these agencies has expanded. The newly appointed chair of the FTC recently announced she was examining the proposed takeover of Twitter by Elon Musk and a group of associates and lenders. The SEC simultaneously intends to examine the disclosures of ESG and compensation. (This could lead to transforming the current cyclical decline, from a bear market in progress to a secular recession/depression, following their FDR model.)  

 

A Bully Hits Someone Who is Down 

 Each week I view stock markets through the lens of mutual fund performance. Most of the time it is wise to pick an investment period that includes an up and down price market for analysis. This week I examined the latest fifty-two weeks, which includes both rising and falling markets. I found that there were only twenty categories that had positive returns out of 110 peer groups. The highest return was for the average commodity energy fund, which gained 97.33%. The smallest gain was 0.12% for dedicated short funds. The vast majority of the winners were asset heavy with a perceived marketable value. There were no intellectual property winners. Inflation is driving stock prices and the government is contributing to it, rather than addressing inflation, the biggest single tax on the financially disadvantaged. 

 

Question: Is your portfolio’s current value keeping up with inflation adjusted spending? 

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

https://mikelipper.blogspot.com/2022/05/three-worries-april-near-term-slowdown.html

https://mikelipper.blogspot.com/2022/04/short-long-term-thoughts-weekly-blog-729.html

https://mikelipper.blogspot.com/2022/04/is-this-great-investment-era-ending.html

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Three Worries: April, Near-Term Slowdown, and Long-Term Euro/Asia - Weekly Blog # 731

                                    

Mike Lipper’s Monday Morning Musings

Three Worries: April, Near-Term Slowdown, 

and Long-Term Euro/Asia

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

April’s Bear Market

Our last blog labeled the three most popular US stock indices with their media pundit titles, which now need to be revised based on this week’s performance. Using the size of the drop from previous high points:

DJIA           -10.39% Correction

S&P 500           -13.82% Correction Continued

NASDAQ Composite  -24.18% Bear Market*

                  

*From 11/12/21 Peak

While the two more senior historic indices have not confirmed a bear market, retail sentiment for the next six month is extremely bearish. The American Association of Individual Investors (AAII) latest weekly survey summary indicates a 59.4% bearish view. This is the deepest bearish percentage I remember. (As a contrarian who is often premature, I am looking forward to a rising market in the indefinite future.) There were 989 new lows for the week on “the big board” and 1570 on the NASDAQ. Investors should be alert to sharply rising stock prices the morning after a down day, where over-leveraged short positions were liquidated by custodians. 

With short-term rates rising, borrowing costs have risen sharply and apparent levels of liquidity are drying up. Toward the end of the month a number of major companies reported earnings that were disappointments. This was due to lack of demand, excess inventory, supply shortages, and an unfavorable mix of workers with questionable skills and attitudes willing to work. Returning to the office is proving to be more difficult and expensive than many thought. No wonder many viewed April as a bad month.

Berkshire Hathaway - Annual Meeting, 1st Quarter, & Best Portfolio Analysis Lab

Berkshire hosted its first physical annual meeting in three years, publishing its first quarter report and providing insightful portfolio analysis. I regularly attend the annual conference, both as a portfolio manager of accounts owning positions in the Berkshire and personally as a long-term shareholder. I left Omaha with a number of insights I would be pleased to discuss privately with subscribers. The following are briefs of those views:

1. The long-expected transition is underway, from an exclusive focus on speaking roles by Warren Buffett and Charlie Munger, to speaking roles by the two Vice Chairs. Additionally, there was the election of a couple of younger directors.
2. The leadership of value-oriented stocks is slowing on a relative basis. In the first quarter, insurance operations and their investments produced poorer results. However, it was expressed that results would be better in the future based on greater use of technology and better training. Furthermore, the railroad needs to improve its results through better training and the possibly of only engineers on trains. While the remainder of the operations also produced acceptable results, some operations experienced supply shortages and slower sales than expected. It would not surprise me that some activities over inventoried, which led to first quarter sales being less than planned. Perhaps as a result, there were no stock buybacks in the month of April.
3. Not surprisingly, investment losses were reported in the first quarter. As a partial offset to these declines, Warren Buffett purchased 9.5% of Activision for the company in an arbitrage operation. (The significance of this is that it was a replay of a formerly regular activity.)
4. In a recent fund manager’s survey, the majority of portfolio managers favored value-oriented securities or loans for the rest of this year. The very current experience at Berkshire does not vigorously support the idea.

My personal conclusion is that Warren Buffett and Charlie Munger are managing the company as if it were a Trust for their and other long-term individual shareholders’ heirs, making Berkshire Hathaway a perfectly sound holding, but not necessarily attractive as a new position. 

History Suggests Ukraine’s Invasion Purposes?

For centuries the European-Asian land mass has been the prize that militant leaders and religions have sought, with a passive and submissive Ukraine an important safeguard. Historically, Russians have believed that control of the continent was providence, first with the “Popes” in Rome, then Constantinople and finally Moscow.

Aggressive leaders - Genus Kahn, Napoleon, Hitler, and Putin believed it, as did students of geo-politics. Where does Ukraine fit in? To control commerce in the Black Sea there must be friendly powers on all its coasts controlling the wealth in the ground in Central Asia, which includes Kazakhstan, the former Soviet provinces, and Iran. The Russians already have a naval port in Syria to protect access to the Black Sea and trans-Asian pipelines. Turkey recognized this threat and recently prohibited Russian flyovers to reduce the strength of Russian forces in Syria. Kazakhstan is also worried. The other big player in the region is China. China sees itself as an exporter of both manufactured goods and some raw materials to their preferred markets in Europe and Africa. There are two transport routes, one through and around Africa and the other by train across Asia and Europe. With the potential for mile-long trains crossing what used to be Russian territory, safe passage is critical. You can see that if the Black Sea is not in friendly hands, the dream of a dominant Russia is dead. I may be completely wrong, but one can see Putin’s motivations.

Questions: Do any of these thoughts suggest different investment strategies to you?

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

https://mikelipper.blogspot.com/2022/04/on-way-to-bottom-weekly-blog-730.html

https://mikelipper.blogspot.com/2022/04/short-long-term-thoughts-weekly-blog-729.html

https://mikelipper.blogspot.com/2022/04/is-this-great-investment-era-ending.html

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A. Michael Lipper, CFA

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On The Way To The Bottom? - Weekly Blog # 730

                                    

Mike Lipper’s Monday Morning Musings

On The Way To The Bottom?

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

When amid a campaign with no predetermined finish, it is difficult to guess both the timing and the result. We are in that position today and the best we can do is guess. Generally, there are two approaches to guessing. The first is to evaluate past contests and the second is to focus on current conditions. I will briefly do both, including two surprising differences.

History

Each market and/or economic decline is different. Pundits use labels for stock markets, such as market phase, correction, and bear market. Economic declines are divided into cyclical and structural. None are tight descriptions, but are somewhat useful in describing what has happened, with some predictive value.

Stock Market Declines

A fall of 20% from a former peak is called a bear market, a decline of 10% is labeled a correction, and a smaller decline is called a market phase. The problem today is the three popular US stock market indices can each be labeled with a different name:

DJIA               -8.82%  =  Market Phase

S&P 500           -12.28%  =  Correction

NASDAQ Composite  -25.06%  =  Bear Market

The majority of the public and therefore politicians get their brief market news based largely on the DJIA. Securities distributors and thin staffed financial institutions use the SPX, while professional traders pay attention to the NASDAQ. No wonder there is confusion concerning the current state of the market and to some extent where it may go. Almost by definition, the greater the decline the sooner a bottom is reached. Long-term subscribers know that I often find the NASDAQ composite a better market predictor than the others two measures. The NASDAQ led both on the way up and down. The reason for this is the junior index having proportionally less passive (index) investors making specific stock judgements. 

If you accept this analysis, then we have reached the level beginning a bottom, as most bottoms occur after a 25% decline. Consequently, followers of the NASDAQ can start to believe the bottom for this market is in range. This view is backed up by the level of transactions on the NYSE and NASDAQ, plus the number of new lows for the week ended Friday. On a year-to-date volume basis, the NYSE is +6.98% and the NASDAQ -6.10%. Last week the number of new lows on the NYSE was 649, versus 1023 on the NASDAQ. (In analyzing the NASDAQ, it is important to recognize that technology stocks were the leading sector, both rising and falling. (In the long-term future, I believe “tech” stocks will be among the leaders, but not necessarily the same names.)

Cyclical or Structural Economic Declines

Cyclical economic contractions are much more frequent than structural changes. Typically, cyclical contractions are caused by excessive money supply growth, which leads to too much borrowing and inflation. 

Symptoms 

We are currently experiencing those symptoms. The M2 measure of money supply growth is currently +13.21% on a year-to-year basis, which clearly includes what politicians call stimulus and I call political bribes. Not surprisingly, this has led to the JOC-ECRI growing +17.37% this year. (The good news is the index dropped 1.51% this week). Consequently, it is reasonable to speculate a recession is in our future.

The critical risk is political leaders transforming a cyclical downturn into a structural one, as they did globally in the 1930s. This is not a prediction, but as a trained US Marine I am always alert to a sneak attack and need to be aware of the risk. There are currently an unfortunate number of parallels with the 1930s. Despite a general economic expansion globally, there is a vocal minority that can be leveraged by politicians (Remember, I believe Mark Twain said the job of a politician is to find a parade and get in front of it). 

Current leadership is becoming more autocratic in several countries. Small regional wars have the potential to become global wars e.g., Ukraine>>>Black Sea >>>Asia Minor >>>>East vs West?.

The French Presidential election demonstrates much of the population votes against. This election conforms to the view that there are almost no popular governments, just more popular than the opposition. This in turn makes long term plans difficult, which in turn also makes investment judgements difficult.

Question: What do you think?

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

https://mikelipper.blogspot.com/2022/04/short-long-term-thoughts-weekly-blog-729.html

https://mikelipper.blogspot.com/2022/04/is-this-great-investment-era-ending.html

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

Short & Long- Term Thoughts - Weekly Blog # 729

 

Mike Lipper’s Monday Morning Musings

Short & Long- Term Thoughts

I. Confusion or Choices

II. Critical Investment Business Trait

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

I.  Easter Week Signals

The US trading week consisted of only four trading days this week. Nevertheless, it created two different implications. A columnist at The Financial Times thought it signified a confused market. I on the other hand thought it implied multiple choices of future market movements. Let me explain. Over the four days 8.2 million NYSE shares traded to the downside, which was more than the 7.8 million shares traded to the upside, suggesting a falling market. On the other hand, the NASDAQ upside share volume was 9.8 million, which was above its downside volume of 9.2 million, favoring the bulls. The often contrarian AAII summary survey reached an extreme bullish reading of 15.8%.

What to me is more significant was that within various investment sectors some leading firms purposely lowered profit margins. They did this by increasing spending on new sectors by adding to their dominant positions. In the financial sector, Goldman Sachs, T. Rowe Price, and JP Morgan Chase spent today’s dollars for new sources of capital, new markets, and new ways to reach new clients. If all they foresaw was a cyclical decline, they like their competitors would have let their profit-margins rise. However, all three made the choice to invest for a broader and probably better future, instead of just enjoying a cyclical expansion. There were similar moves in other sectors. Long-term investors should think about these expenditures when considering a future bull market. 

(I have cautioned blog readers that I would be looking across market valleys to the beginnings of subsequent rising markets.)

II. Critical Investment Business Trait

We are always searching for new investment advisors of funds, or separate accounts, while simultaneously reviewing existing holdings. If you think it is difficult to select funds and managers for future performance, I can assure it is more difficult than choosing individual securities. 

I attempt to learn the business traits of portfolio managers and their business leaders. As it is unlikely I will be present when an actual or potential investment opportunity surfaces, I rely on my memory as to how the manager reacted to similar opportunities in the past.  The key to that muscle memory is budgeting.

One of the many missing topics for CFAs and others is budgeting. If they are the keepers of clients’ wealth, it is helpful to see how they spend their time. 

• Managers in every period spend at least 50% of their time on existing holdings, including following competitive positions.
• Managers new to their responsibilities should spend another 25% searching for new or better names. Even established portfolios should attempt to increase new names by about 10% each year and  market cycle. 
• The remaining time and talent should fill two buckets. 
• The first should focus on the care of clients, helping them to become more aware of the realities of the investment process as applied to their own situation. 
• The final bucket should be part of the firm’s early warning system, being aware of new competitors, people, or ideas. 

The ultimate responsibility of the manager is to secure the clients longevity beyond the manager’s employment. You guessed it, budgeting is the heart and soul of managing, something not taught to CFAs and others.  

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

https://mikelipper.blogspot.com/2022/04/is-this-great-investment-era-ending.html

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

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

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

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

 

Mike Lipper’s Monday Morning Musings

Is This Great Investment Era Ending?

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

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

The following observations may be germane to the analysis:

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

Please add your own observations and communicate them.

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

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

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

What do you think?

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

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

Thoughts?                 

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

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

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

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

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.

WWIII Slightly Delayed, Bear Market Accelerating, Prepare for Bull Market - Weekly Blog # 727

 

Mike Lipper’s Monday Morning Musings

WWIII Slightly Delayed

Bear Market Accelerating

Prepare for Bull Market

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

Chatter from Moscow, Turkey, European Capitals, and the confused and confusing White House, seems to indicate attempts to avoid raising the price of confrontation, with the hope that internal political problems in almost all countries will lead to lower military commitments. Possible but unlikely based on US actions before WWI and WWII, which appears to be the script that the former Obama White House staff is following through their statements. Focusing on socially restructuring the US economy instead of spending on qualitative and quantitative defensive needs has opened the window for aggressors. This has happened twice before and appears to be happening again. The political focus on US domestic policies and the growing gap in preparedness has encouraged the aggressors to attack.

In the long run our growing weakness is perhaps the product of the schooling system, from Nursery school up through PhD programs. It has produced many uneducated, undisciplined, and unhealthy students unsuited for the military and entry-level jobs. 

Bear Market Signs

Current and prior administrations saw imbalances in the economy through a top-down approach. They found it acceptable to increase money supply growth, which eventually led to an increase in the size of the federal deficit that unleashed inflation from its constraints. Today, many look back on 2019 as the base-case for a healthy economy, although problems existed on some corporate and personal earnings statements. There were clearly social imbalances and school systems were well on their way to producing unemployable people. 

Many see the large jump in 2021 earnings and extrapolate those gains further into 2022. However, if one looks at the growth rate from 2018 through 2022, it is far lower than prior growth rates and precedes the anti-profit and anti-trust executive actions proposed by the current administration. We are currently seeing materially lower earnings projections and planned tax increases that will hurt earnings in 2023, which will potentially impact corporate spending in 2022. 

The one main securities sector enjoying the current market is the energy sector, which The White House is blaming for inflation and suggesting it should be punished, rather than taking responsibility for its own actions. These actions are not going to lead to increased capital expenditures in the “oil-patch”.  

Preparing for the Next Bull Market

As I have previously mentioned, I am trying to focus where possible on looking across the valley of the bear market and likely recession to climbing out of the swamp and beginning the next bull market phase. I have written in the past that if one slashes the wrist of a securities analyst a historian will bleed. One advantage I have over most other market-oriented analysts is access to the portfolio holdings of many open and closed-end type vehicles around the world. Rounding out this area, I also review the financials of a more limited number of fund management companies. From these inputs I have gathered some observations that have led to successful long-term investment performance. I intend to share these thoughts with our subscribers through forthcoming blogs.

#1 Biggest Contributor to Performance

Rarely in securities analysis courses or books is the importance of weighting portfolio components attributed to long-term performance results. Interestingly, when writing the Investment Company Act of 1940 at the Mayflower Hotel in Washington, the fund industry lawyers recognized the importance of weighting as a characteristic to fund owners. 

Most funds are legally designated as diversified funds, which restricts the initial cost for each security to a maximum of 5%. As a practical matter, very few funds are so concentrated that any position exceeds 5% at cost. Additionally, most funds do not want to have any single position represent more than 10% of the voting shares of a company. Doing so would classify them as an inside investor and would impact the tax treatment of the sale of such a position. Most large funds chose to own many positions, with a large position representing 2% - 3% of the portfolio. An S&P 500 index fund will obviously own 500 plus stocks. 

Every stock, at any given time and price, has its own potential risk and reward in the eyes of investors. By combining these stocks with others, the entire portfolio takes on its own risk/reward characteristics. The smaller the number of positions, the larger the impact of a single position. I prefer a concentrated portfolio when I have confidence in a fund or manager and prefer a portfolio with a larger number of holdings if I am less confident but still want to participate in the market or sector. This is the filter many use in their selection of managers.

Over time, as holdings rise or fall due to changing prices, it is not unusual for a portfolio to have a limited number of holdings do very well while another group does relatively poorly. For illustration purposes, take a highly concentrated portfolio with initial positions of 5% each. After a length of time, the 10 best performing positions might represent 75% of the portfolio instead of the initial 50%, with the bottom 10 representing 25%. The winners will then represent 3 times the amount of the losers. Without a reversal in fortune, you would be far less diversified and could be more at risk of a loss.

Many of us initially take small position sizes when entering a new position, resulting in many holdings over time. However, some of the newbies don’t work out and some of the larger positions decline in relative value, causing wealth to not grow proportionately. We generally own a number of heavy hitters and a farm team. I recently looked at a very successful portfolio which had grown many multiples of its initial cost. Even though there were very large gains in 10% of the positions and 90% of the stocks were unproductive, wealth grew many times its starting value. This result was due to 10% of the stocks producing 90% of the gains.

One can also weight by industry or investment characteristic. For example, turnaround, new product, low cost, good management, takeover potential, local business, yen based, etc. The important point in terms of analysis is to divide the portfolio into meaningful segments that lend themselves to making useful decisions.

For a limited number of subscribers wishing to have a discussion, please send me your portfolio data and I will be glad to help use this tool in decision making.     

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

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

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

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

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