Short or Long? - Weekly Blog # 742

 

 

Mike Lipper’s Monday Morning Musings

 

Short or Long?

 

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

    

 

             

A short or long recession appears to be the critical question on most economically oriented people’s minds. As is often the case with a popular question, it is the easy but wrong question. The right question is, what impact will the soon to be declared recession have on our future economy, society, and investments?

 

Historians typically find an over-riding cause for the period between expansions. The declines that have the greatest impact on future expansions are not primarily to reset price levels but to address economic imbalances in society and focus on the critical forces shaping the future.

 

When most people discuss the future, they focus on the factors producing a result pleasing to them. Currently, the popular view is that the recession will be short and shallow. Well, it might be, but it’s appropriate for thinking people to consider at least two major outcomes, and others.

I have no special competence to divine the future but feel compelled to think about the alternatives for our clients and family.

 

Short Recession

Favorable Indications

A market analytical tool that has been around for more than one hundred years requires two Dow Jones stock averages to be going in the same direction.

 

The question is whether we have already not only entered an economic recession but are demonstrating signs of a bottom.

 

The chart pattern of the Transportation Average is showing early signs of a market bottom, with the Industrial Average further behind in its chart development.

 

To me the Transportation Average is a more reliable indicator of what is happening, with the Industrial Average an indication of what investors think about the future.

 

I wonder whether the current administration, like President’s past, will declare operating railroads essential to national defense and step into what looks like a pending national strike.

 

Industrial prices lead wholesale, retail, and consumer prices. The JOC-ECRI Industrial Price Index fell -3.14% this week and is down -9.29% year over year, with Oil, Copper, and Wheat among the drivers.

 

On balance I am more impressed with the trading skills of those using NASDAQ stocks, than those limiting themselves largely to NYSE stocks. In the latest week, more shares listed on NASDAQ rose than fell, 11.4 million vs 10.2 million respectively. The opposite was the case on the NYSE, with 8.3 million rising and 11.2 million falling.  

 

Traders are demonstrating better timing than investors but not gaining as much.

 

Unfavorable Indications

Sloppy analysis uses stock prices being historically attractive, with current prices and the last reported earnings or estimates. The price/earnings ratio on this basis has dropped to the long-term average range. Usually, a sign of value is when P/Es are substantially below average.

 

Quite a few recently reported earnings were substantially below prior estimates. As bad as these reports were, I wonder whether they captured the deterioration of their businesses. I have not seen write-downs of the values of their inventories due to lower priced raw materials, the shift of customer buying practices to more essential goods, or the slower payments of accounts payable.

 

As a publishing entrepreneur I had to deal with some of the biggest financial institutions in the world., They were slow payers. Meanwhile, I had to pay our people on time, as well as our rent. I did not “factor” or borrow against our receivables as the lenders would have discounted their value, even though they all eventually paid.

 

When we investigated investing in troubled or bankrupt companies for clients, we discounted receivables and wrote down both raw materials and finished goods inventory, as well questioning the value of fixed assets. If we could find a going concern buyer for which we ascribed value to the prospects not there, we attempted to ascribe value to their hard-working and highly competent work force and good customer relationships.

 

A recent Financial Times article heralded the end of the easy to borrow money period, making acquisitions more expensive and difficult to do. Plus there will be fewer opportunities for M&A and IPOs

 

Each week The Wall Street Journal list the prices of 72 security and commodity indices, as well as currencies. In the latest week 75% went down.

 

Working View

The betting odds seem to be against a quick, short recession, but it could happen. If it does happen, I don’t think we will address the serious questions holding us back from our optimum potential.

 

Odds are, if we have a short and shallow recession, it will in time be followed by a longer and deeper recession addressing some of our problems.

 

Unaddressed Problems

1. The average US high school student ranks 37^th in international rankings in math and science.
2. The groups dictating to our medical system are tort lawyers and insurance companies, which is not conducive to producing the best healthcare for us.
3. A declining military system more interested in social goals than possessing enough power and training to deter potential aggressors.

 

 

 

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

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

https://mikelipper.blogspot.com/2022/07/mike-lippers-monday-morning-musings.html

 

https://mikelipper.blogspot.com/2022/06/switching-prime-focus-weekly-blog-739.html

 

 

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Time to be Contrary? - Weekly Blog # 741

 

Mike Lipper’s Monday Morning Musings

 

Time to be Contrary?

 

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

   

 

 

Inconclusive Week

Few US stock market participants considered the news of the week as a reason to significantly change their current investment position.

Bear markets result from market transactions based on investment outlooks, which are sometimes wrong. Recessions are economic downturns. Most often bear markets lead to recessions, but not always.

Nothing very good or bad came to investor’s attention. The news about employment, inflation, interest rates, and politics, slightly encouraged people’s biases but did not lead to any reversal of opinions.

Two things a historian might add are: 

• A growing view that the oncoming recession will be slight and probably quick. (Interest rates from 2 to 30 years are remarkably flat for US Treasuries.) 
• A quick, shallow recession leaves little time and momentum to correct multiple imbalances in our society.

If we are not going to address our problems we should focus on the recovery, which may be shorter than in the immediate past. With that possibility in mind, one might examine some contrary thoughts concerning various portfolios.

 

Understanding Contrarian Thoughts

Contrarians probably recognize that no single school of thinking produces winners all the time. Furthermore, contrarians are not smarter than those more comfortable alongside the perceived majority of “smart” people.

The differences between the two types of thinking are as follows:

1. The majority extrapolate current trends or views, whereas contrarians expect change, even if it goes back to some prior period.
2. When the majority are correct in their predictions the returns are normally relatively small compared to those earned by contrarians. Even with the majority being correct more often than contrarians, over many cycles they will earn less.
3. As neither type of investor totally avoids mistakes, losses need to be considered. When the majority wants to exit it will have lots of company, which can depress exit prices. Since contrarians don’t invest in popular issues, they typically don’t pay extravagant prices. Consequently, their exit prices are usually closer to their entry prices. The majority loses dollars, the contrarian loses time.  

 

Summer Contrarian Thoughts

Current markets appear to rotate more on changes in sentiment than on reported financial and economic results. We won’t officially know for some time whether we are entering a recession, although many feel we are already in one. We clearly have been in a bear market decline from the peaks in January of ’22 or November of ’21.

It is quite possible the recent decline in retail goods sales is the result of growing recession chatter.

This blog is written for long-term investors, not short-term traders. Traders and investors are often on different sides of a trade, with each being right based on their own period and performance standards.

For the moment, regardless of your own point of view, assume we are progressing through a bear market into an economic recession of some length and depth. Nevertheless, we believe that at some point in the future we will be in a rising market and an expanding global economy.

Our task is to select winning investments for a lengthy period or periods. A good place to start our search is the performance periods ended June 30, 2022. As a contrarian one would reverse the performance ranking order of various investments, including mutual funds and individual securities. 

This process creates a search list, not a performance roster. Not all securities reverse their relative performance rankings as they move from one market cycle to the next. The critical research depends on finding new reasons the security in question is appropriate for the change in conditions in the new cycle. A few will.

 

An Analysis of Market Price or Market-Cap Indices can be Helpful

The Dow Jones indices are weighted by market price, whereas the S&P is weighted by the number of shares outstanding multiplied by the stock price. While the publishers make the original name selections, the individual weight of a stock is influenced by the movement of the stock price for the Dow indices, and the price multiplied by shares outstanding for the S&P.

They are both popularity measures and during periods of up or down trends their movement is determined by the unexplained actions of market participants, not direct investment judgement.

We see the same thing at racetracks using the pari-mutual odds system.  Winning horse backers are rewarded based on the ratio of the aggregate amount bet on the winner compared to all other bets, less the “take” of the track and taxes. The horse bet on most is called the favorite. All other entries will make more if they win, sometimes a great deal more than successful bettors on the winning favorite. Historically, favorites win around one-third of the time, thus those who bet only on favorites must lose in aggregate over time.

This is not necessarily true for index investors because markets go up most of the time due to dividends and expectations. However, this is not always true as in the first half of ’22, where the major stock indices were sharply down for the period. The S&P 500 index is made up of eleven component sectors and only energy stocks rose, representing just 2% of the index.

One problem for the S&P 500 index is the way market capitalization works. Of the 11 sectors, 8 performed worse than equal weighted sectors. Thus, in aggregate the weighted judgment in the market was wrong for this time-period, just like most favorites at the track.

I am not suggesting the market is always wrong, but it can be wrong some of the time. My investment suggestion is, if you select an index fund to participate in an up market, a weighted index fund makes sense on average. If you are more risk averse and feel more pain from periodic losses than from a similar gain, an equal weighted index fund is better. An equal weighted index may also be a bit safer if the current market trend has been going up for some time.

 

Is your Income or Spending Influenced Beyond the Border?

Since Adam Smith published “The Wealth of Nations” in 1776, I believe almost everyone has been influenced by different price levels, the availability of products, and opportunities influencing what we spend and earn.

Scott Galloway, a NYU Stern Professor, noted that this is in part due to individuals with foreign backgrounds coming into our country. He said “Almost half of Fortune 500 companies were founded by American immigrants or their children and more than half of unicorns (private companies worth more than $1 billion) are founded by immigrants.

While the data is not transparent, it is reasonable to believe that at least 25% of US reported corporate profits are sourced from our exports or foreign operations. Thus, I believe that for long-term investment portfolios to generate the level of income needed to buy all the items that we import now or in the future, we must invest a portion of the portfolio abroad.

If a sound long-term multi-generational portfolio is to be well balanced and provide income for consumption, it should probably be invested in both growth and value stocks. The latter’s time horizon is probably shorter than growth investments and more likely to be domestically oriented. (Due to legal and tax issues)

A reasonable approach is to look for more international representation in the growth portions of the portfolio. This is buttressed by the better math and science scores at secondary schools overseas.

The value of the dollar has been rising, not because things are getting better here, but because of local economic problems elsewhere. As a contrarian this seems to be an opportunity to buy cheaper foreign currency instruments for a long-term portfolio. Long-term investment opportunities in companies doing business in Asia should be considered due to demographics, discipline, and supportive governments.

 

A Contrarian View on Private Investing Now

One lesson from both the track and investing is that a crowd of new participants signaling excessive enthusiasm can lead to a bubble. A sign of this risk building is highlighted in a recent Wall Street Journal article headlined “Private equity Poaches Talent to Chase Wealthy”. Wonderful returns have been generated from investing in private equity and somewhat less in private debt. My concern is that practically every financial services organization is offering services to the private market. We are already seeing private companies delay going public to get higher prices through constant money raising. At some point prices will reach a peak and collapse. Successful contrarians try to not be late and avoid waiting for bargain prices.

 

Please Share Any Agreements or Disagreements

 

 

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

https://mikelipper.blogspot.com/2022/07/mike-lippers-monday-morning-musings.html

 

https://mikelipper.blogspot.com/2022/06/switching-prime-focus-weekly-blog-739.html

 

https://mikelipper.blogspot.com/2022/06/are-markets-getting-too-far-ahead.html

 

 

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Stress Tests - Weekly Blog # 740

                                    

Mike Lipper’s Monday Morning Musings

Stress Tests

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

Next Phase

Investors are not happy with the current phase of the market, which could be labeled a transition starting in late 2021 or January of ’22.

We left a stimulated expansion and rising US stock market for a contracting “bear market” and likely economic recession. 

The stock market performed its traditional function by discounting the future and falling before an economic contraction began.

The Federal Reserve was on its original mission, performing the function that it is perhaps best suited to accomplish, the protection of the banking system. (One can question the wisdom of assigning other responsibilities to the Fed.)

The Fed has learned that banks should have balance sheets assuring their survival in potential economic contractions. The Fed consequently required banks to show they could survive possible severe economic conditions, without necessarily predicting them. 

The tool used created very severe stress tests. The way the Fed used these tests limited the bank’s commitment to expansion and dividend increases. All banks passed the minimum requirement in the last stress test, although JP Morgan Chase and Citi were refused permission to immediately raise their dividend.

Many were shocked that JP Morgan was not given permission to raise its dividend. Afterall, the country’s largest bank had styled itself a fortress to defend its depositors from major problems. (Including ourselves) From the Fed’s perspective the bank was expanding too fast, especially if a very serious economic contraction materialized.

Surviving investors learn from changing conditions and I am now applying stress tests to how I manage money for clients and my family.

How Deep & Long a Decline

Applying an overly stringent set of filters to the oncoming contraction is creating stress for me and our accounts. Over the last two weeks the US and Chinese stock markets rose, while bond credits and commodities declined. A rise in stock prices is normal during bear market rallies on below average volume. 

The decline in the other asset types is worrisome, as they tend to be owned by more risk aware investors. In general, these asset types generate less capital appreciation than the average stock and are time constrained. Stock investors often view moves within the fixed income and commodities markets as warnings for the stock market.  

An offset to this bearish picture is to remember that falling prices and low volume should be viewed as an opportunity. Howard Marks, an old data client and very successful investor is quoted as saying “Today, I am starting to behave aggressively”.

Strategic Selections

Picking the highest performing strategy at the exact right time will produce great results, but good luck achieving that. 

For prudent risk-aware investors, a more comfortable strategy is the right combination of a limited number of strategies. This is an artform that great portfolio managers demonstrate most of the time.

My personal stress test perceives the adoption of at least five logical strategies as we exit this interregnum phase.  

Five Strategies

1. There have only been a small number of bear markets without a follow-on recession. One example is the Fed’s gigantic growth of money supply during the Trump period. It came so fast that a “value investor” like Warren Buffett did not have the opportunity to buy large amounts of good companies at fair prices.
2. In a “normal” cyclical recovery, asset prices for stocks drop to sounder levels as probable results are discounted. 
3. Structural recessions usually address economic imbalances through the liquidation of debt, which often requires a well-known financial player to collapse in some financial crisis. Currently, the largest debtor relative to revenues is the US government. (The continuing obligations of the US government are materially greater than its tax revenues, leading to increased levels of deficits.)
4. A depression is triggered by the political establishment policy mistakes intended to solve short-term problems requiring deep social restructuring. A classic example was the tax and tariff policies of the late 1920s, followed by the radical restructuring attempts in the 1930s. This turned a 5-year cyclical recession into a 10-year depression.
5. Stagflation occurs in a period of slow revenue growth combined with high inflation and unwise regulation. We suffered such a period in the 1973–1982-time frame.

The five strategies listed are in rough order of the shortest expected lapsed time in a bear market without a recession, and the longest stagflation. Another critical time scale is your expected investment period. For the longest periods, e.g., a grandchild’s college endowment, very little in the way of reserves are needed. More reserves are needed to offset potential losses due to unfortunate timing in shorter time periods.

Selection Guidance

Over extended periods, the aggregate performance of “growth” and “value” are about equal. However, there are two main differences in the selection process; tolerance for volatility and how the main financial screens are utilized.

Growth investments tend to be volatile based on news. You consequently need to pay intense attention to any element impacting the income statement, particularly net cash generation excluding all uses of cash or buying power.

Value investments appear less frequently in the media and thus tend to be less volatile. This is particularly true if they pay a regular dividend, which is hopefully growing. The adjusted balance sheet is the most important document in their selection and includes the current pricing of all assets and liabilities. Additionally, the value of people, customers, brand name, patents/copyrights, or under-utilized resources need to be added. You need to add all reasonable contingencies, including the shut down costs of work sites and people. In many cases, a forensic accountant and bankruptcy lawyer is needed.

WHICH DIRECTION?

The main reason this blog is titled “Stress Test” is that there are currently “green shoots” of positive information as well as disappointing signs. Reasonable analysts may disagree on both the importance and characterization of listed items in the proper category. Nevertheless, I pay attention to all as possible signals of things to come. 

I welcome all views that agree and disagree the view expressed.

Positives

• The JOC-ECRI Industrial Price Index weekly change was -2.47%
• The AAII 6-month bearish view was 46.7%, vs 59.3% the prior week. (This was a move back from a very extreme position the prior two weeks, viewed by market analysts as a contrarian indicator.)
• Copper prices are recovering from a high price in April due to rising Chinese demand.
• In last 3 months, M-2 money supply growth was only 0.08%.
• Fed funds futures prices are dropping.
• The bond market appears to be capitulating,
• The combination of China producing both a hypersonic stealth bomber and a 4th generation aircraft carrier, should be good for defense spending.

Negatives

• According to the American Farm Bureau annual survey, the cost of a July 4th picnic has risen 17% in the past year to $69.68.
• Tech companies, among others, are laying off workers.
• The Atlanta Fed is forecasting a second quarter contraction of 1%. 
• I wonder how much of the relatively low trading volume on Friday was short-covering before the long weekend.
• The claim that the market is priced more attractively now than earlier in the year looks questionable, as pundits are using current prices and what I believe to be “stale” earnings estimates. The severe drop in June sales may have led to considerable write-downs of inventories and prices. 

IT IS IN PERIODS LIKE THIS THAT INVESTMENT MANAGERS EARN THEIR FEES.

 

Please share your thoughts for the next great investment idea.

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

https://mikelipper.blogspot.com/2022/06/switching-prime-focus-weekly-blog-739.html

https://mikelipper.blogspot.com/2022/06/are-markets-getting-too-far-ahead.html

https://mikelipper.blogspot.com/2022/06/pick-investment-period-strategy-weekly.html

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Switching Prime Focus - Weekly Blog # 739

                                    

Mike Lipper’s Monday Morning Musings

Switching Prime Focus

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

Functions of Analysts & Portfolio Managers

Many analysts who publish their work focus on just reported results, and to a minor extent estimates of the next to be reported results.

As a contrarian thinker, I am used to being lonely in examining longer-term results. Consequently, I accept that my views may well be very different than what occurs.

Portfolio managers should be focused on expected prices at termination of time periods critical to the account. That is the easer part of the job. The more difficult task is the construction of a portfolio to accomplish the investor’s goals within given time periods.

Both analysts and portfolio managers will only be right some of the time. The critical task is to limit the overall damage to the portfolio and achieve the best delivery for the investor.

Why Switching Now?

In almost all sports, as in life, the best results come from the appropriate combination of anticipatory aggressive and conservative moves.

Coming off a successful effort to call last’s week equity performance, where the Dow Jones Industrial Average (DJIA) generated an 800-point gain on Friday. News reports and commentaries have been more mixed than when I started to mention my more bearish comments over a year ago. With the NASDAQ in a bear market and both the DJIA and the S&P 500 in a correction, I should question my own views. (The S&P 500 was temporarily in bear market territory)

Bearish Comments

Former Democratic US Treasurer Larry Summers said, “We need unemployment above 5% to contain inflation for five years, 7.5% for two years, or 10% for one year.”

Corporations and individuals choose to move for a number of economic reasons, including the new location being better for their relocated and new employees. Citadel is moving its headquarters from Chicago to Miami. Both Chevron and Goldman Sachs are moving major portions of their office staff from crime infested, high tax states, to Texas. 

Copper prices have reached a 15-month low. A significant development due to its use in many manufactured products and economists calling it an economic predictor.

The prices paid for the “free lunch” SNAP program has risen 23% in a year. I don’t know how much of this is due to the war in Ukraine, but it does not seem this tragedy is going to get less expensive or end quickly.

Political Lessons

Almost all economic cycles are caused by humans. Among the easiest to spot and perhaps correct are those made by politicians in power from both major political parties.

Perhaps the single biggest problem created results from elected politicians turning over issues to non-elected administrators, which they do because they don’t have sufficient votes to pass them. 

For example, this weekend the decision on abortion was punted. Elected politicians in Washington, recognizing this topic was likely to split the population, decided to let the states decide. On Friday it went through to the Supreme Court, because in eyes of some, the local laws were in conflict with the US Constitution. We need to remember that the Supreme Court makes judgements based on law and legal precedent, not moral judgement. 

The mistake politicians in Congress made for a period of at least twenty years was asking candidates for their opinion rather than crafting a national law addressing the problem.

This is their common mistake, they turned to unelected and largely untrained administrators to solve a social problem. We see this approach being used for issues before the SEC, FTC, Treasury, State Department, Agriculture, Labor, Interior etc. (In my opinion, it is just a matter of time before various administrative decisions are struck down due to exceeding their legal mandate to act without passed legislation.)

One reason politicians act is polling, although polling has proven to be quite inaccurate in close elections. Polls are also conducted by low-cost brief phone calls to those willing to venture opinions to structured questions. 

In the days when I was interested in polling, I found how I asked the question influenced the answer. This is not an unusual view. It is no wonder a growing percentage of people called do not wish to answer the questions. These “no answers” are not tabulated or properly investigated.

Some Incomplete Conclusions

While I did not recognize it at the time, I took a graduate business school course entitled “Security Analysis” as an undergraduate at Columbia. The Professor was David Dodd, with the adjunct professor Benjamin Graham writing the first academically popular book on the subject. 

This is the course and book which provided the foundation for what has been called “value investing”. There were three problems in the way it was taught. 

1. It was based on the investment experience in the 1930s that made both Graham and Dodd wealthy.
2. Perhaps because of the constraints of a one-hour class, we were instructed to disregard inventories in our valuation and the recalculation of book value when restructuring balance sheets. This was a good first cut, but some finished product inventory had value. Also, debts could and were renegotiated to lower amounts. 
3. The third set of missing elements were the items not on the balance sheet. For example, long-term leases on valuable locations, railroad right of ways, new valuable products under development, immature customer relationships, physical and other location advantages.

In my discussion with the good professor, he discarded my questions related to growth. What I now realize is that he was essentially teaching a course on the use of accounting statements for investing. These are necessary, but insufficient.

Today, a price/book value or tangible value is a paper cover of a book, not the book itself. Far too many investment reports state the relationship without detailed analysis.

Positives

The largest positive is that we have probably been in a recession for all of 2022, and possibly longer. Months later, NERA will identify when the official beginnings of the recession. Regardless, time spent on the way down eats into the time in recession, which on average lasts 32.5 months or a median of 27.1 months. 

The JOC-ECRI Industrial Price Index fell -0.44% this week because port delays got shorter and container rental prices dropped.

Both biotech/pharma and electronic technology are on the verge of exciting new products. For example, Apple’s AR headsets could open a new stream of products. (Apple is owned in personal accounts.)

Due to China launching its fourth super-carrier, defense procurement spending will eventually rise.

What to Look For?

I don’t know yet, but these are some of the things I am looking for:

• Long-term survival skills. This means cutting some things to improve efficiency, but not a critical new product or service.
• Investing in the right client relationships
• Developing the right international friends
• Securing the right financial relationships.

Final Thought

Is there a timing connection between the extreme AAII bearish reading of 59.3% and the recognition we are in a recession?

Please share your thoughts for the next great investment idea.

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

https://mikelipper.blogspot.com/2022/06/are-markets-getting-too-far-ahead.html

https://mikelipper.blogspot.com/2022/06/pick-investment-period-strategy-weekly.html

https://mikelipper.blogspot.com/2022/06/mike-lippers-monday-morning-musings-how.html

Did someone forward you this blog? 

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A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

Are Markets Getting Too Far Ahead? - Weekly Blog # 738

                                    

Mike Lipper’s Monday Morning Musings

Are Markets Getting Too Far Ahead?

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

Caution

The function of trading markets is to discount future results. As with any predictive exercise, one should recognize judgement mistakes will happen. One major predictive mistake is to get too far ahead of future results, often caused by not recognizing the ebb and flow of future events prior to conclusion.

Connecting many current predictions, we are absolutely going to go thru the following stages, all in predictable time periods.

Bear Market  >  Recession  >  Political Change  >  Bottoms  > 

Recovery  >  Buying Opportunities  >  Bull Markets

Note: there was no mention of mistakes and inconsistences.

Incomplete evidence is popping up suggesting the stock market will return to form and force us to be humble. My best guess is that before we get a formal call that we have entered a recession, we may go through a somewhat violent trading surge first. It will cause some to question the inevitability of a meaningful recession, although the result will not preclude a major decline from causing a restructuring.

Current Evidence 

1. For the last 2 days of the week, major US stock indices explored lower prices but closed above their lows.
2. While the Dow Jones Industrial Average (DJIA) had only one rising session, the Dow Jones Transportation Index had two. (I believe the transportation index is a better judge of current conditions than the DJIA, which has more of a future orientation)
3. Last week, there was only one stock price index which rose out of all the S&P 500 indices. (This is unlikely to be repeated regularly.)
4. The number of shares traded on the NYSE had more volume for the week than the NASDAQ, with 17 million shares declining and 14 million rising. The volume of trading on the NASDAQ was essentially even, with 14.58 million advancing and declining. (As expressed in the past, the NASDAQ has more active traders than the NYSE and consequently is more useful for predictions.)
5. The JOC-ECRI industrial price index declined -3.4% this week.
6. Market analysts often believe the results of the American Association of Individual Investors (AAII) survey should be viewed as a contrarian indicator. This week, the AAII bearish indicator was an extreme 58.3%, up from 46.9% the prior week.

I believe the odds favor more upside than downside well into July.  The Atlanta Fed’s current GDP reading may soon indicate a flat or contraction estimate, with a possible confirmation by the Federal Reserve on July 28th.  (The 35th anniversary of “Black Monday”)

Fixed Income Signals

Stock investors have learned to pay attention to price movements in the fixed income markets, which tend to be more sensitive to price risks than stock jockeys are.

While the yield curve has been rising sharply for short to five-year maturities, it is essentially flat for five to thirty year maturities.

The collective bet is that inflation will not rise beyond five years. (What does this say about the Presidential election of 2028?)

One sign a bottom has been reached is when an important group of investors capitulates to the current trend, selling out of their positions quickly.

Some believe investors in credit instruments have capitulated and sold off their credit instruments, a move not echoed in the high-quality bond market. This week, the largest net redemptions in the Exchange Traded Fund (ETF) market were high current yield funds (pejoratively called “junk bonds”). The redeemers were reacting to a perceived increase in credit risk.

The concern bridging the fixed income market and the stock market is the belief in book value on corporate balance sheets. Book value is based on historic cost less depreciation of fixed assets, which can only be written down, not up. One popular “value investing” approach is to buy shares of a company whose price is below book value. However, if current stock prices do not adequately price book value due to changing conditions, the current book value discount may not be accurate.

Thus, some of the fears expressed in the fixed income world can travel into the equity world, making some stocks risky.

Political Warning

General George Washington warned us about political parties, which is as true today as it was at the founding of the USA.  He said the following:

“However political parties may now and then answer popular ends, they are likely in the course of time and things, to become potent engines, by which cunning, ambitious and unprincipled men will be enabled to subvert the power of the people and to usurp for themselves the reins of government, destroying afterwards the very engines which have lifted them to unjust dominion.”

(This quote was part of The American Rhapsody performance delivered at the final concert of the season of the New Jersey Symphony. The US has been blessed by the wisdom of its founders.)    

Please Share Your Thoughts

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

https://mikelipper.blogspot.com/2022/06/pick-investment-period-strategy-weekly.html

https://mikelipper.blogspot.com/2022/06/mike-lippers-monday-morning-musings-how.html

https://mikelipper.blogspot.com/2022/05/bear-markets-recessions-not-inevitable.html

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Pick Investment Period & Strategy - Weekly Blog # 737

                                    

Mike Lipper’s Monday Morning Musings

Pick Investment Period & Strategy

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

This is the 737th blog which shares my thoughts on different investment periods and strategies. They are different from each other and are partly triggered by Friday’s US stock market decline, which in the extreme took 10% off the average price of narrow industry groups.  The views expressed are for the beginnings of internal discussions, not final conclusions which I would be happy to discuss.

Last Week

The 8:30 am Consumer Price Index (CPI) shocked some market participants, but really shouldn’t have shocked those who’ve visited retail locations. From the opening bell until the close stock prices fell. A significant price gap developed between Thursday’s close and Friday’s prices. Most of the time, significant price gaps are closed in subsequent trading before a change in direction continues.

Bullish traders could be overjoyed by Friday’s price action, which showed a considerable increase in volume. They will look at the result as a successful test of an earlier low price.

During the coming week the Federal Reserve will have a regularly scheduled rate setting committee meeting. Prior to Friday’s price decline it was generally expected to be a 50-basis point interest rate increase. This may happen, although the key for the market is not the rate but the issued statement. Some think the market move may scare the Fed into raising rates higher or lower and could also change the announcement related to cutting assets on the balance sheet. 

Market analysts are focused on the price level of the S&P 500 (SPX), whose prior low point was in the low 3800 level. If it were to be breached, a “bear-market” would be called. Some believe the ultimate SPX decline could be in the 3000-3500 range,

Hopefully, what transpires doesn’t mirror Boeing’s launch of an essentially brand-new plane following their very successful 737. Early on, the new plane had some crashes.

July Numbers Difficult to Interpret

• Market sentiment was largely positive in the first half of June, then turned negative in the middle of the month.
• Interest rates on non-government paper rose as retail sales dropped.
• Government numbers focused on a middle of the month week and probably didn’t fully recognize the deterioration of conditions.
• If the very current sentiment continues, I expect the reports for June, published in mid-July, to show a further decline in sales and a gain in inflation.
• If the second quarter GDP is like the first quarter, it will be the second consecutive quarter of contraction, the definition of a recession. 
• For the latest week, six of the ten commodity rail-carload groups showed declines: Other -15.4%, Metallic Ores and Metals -13.5%, Petroleum and Petroleum Products -7.6%, Farm Product and Food -5.6%, Forrest Products -2.9%, and Coal -2.0%. Total Intermodal -4.4% and Total Traffic -2.8%. (As these represent sales to customers, they denote current market activity not building inventory by the producers.)
• The level of interest rates in part deals with expectations. Thus, read what Randy Forsyth in the current Barron’s wrote. “If interest rate expectations are still too low and earnings forecasts too high, don’t be surprised if stocks get sliced further.”

Stagflation

• The World Bank is warning that the global economy may suffer 1970s style stagflation. According to them, it is possible world growth could be close to zero over the next 2 years.
• There is a view in many “advanced” countries that the will of principal taxpayers is to not follow their spendthrift governments by increasing their debt load in a slowing economy.
• According to some economists, the US suffered stagflation between 1973 and 1982. (I started Lipper Analytical in 1973) 
• Frankly, I don’t fully remember the period as I was quite busy building the firm and growing the family, so I asked an associate to research which mutual fund peer groups did best and worst. 

For the ten years ended in 1982 the top 5 peer groups in aggregate were:

       Precious Metals        +346.74%

       Convertibles           +220.51%

       Small-Caps             +214.81%

       Equity Income          +181.63%

       Growth & Income        +156.10%

Except for Growth & Income, these funds groups did not attract a lot of assets. The growth in assets was below $1 Billion in total, indicating the bulk of the industry produced good savings products, but not great investments as a group.

The five worst performing peer groups were also not popular with investors. Their 10-year performance is shown below:

        Short US Government   -10.22%

        Natural Resources     +23.37%

        GNMA               +56.11%

        Financial Services    +57.15%

        Miscellaneous         +64.43%

• To find individual fund groups that were extreme performers we looked at the two best and worst for each year. Not surprisingly there were only a few repeaters.

The most consistent winner were Precious Metals funds, at the top five times but also at the bottom three times. This seems appropriate in a period of rising inflation. Not surprisingly, Global Natural Resources finished at the top for two years. (During periods of high global inflation escaping out of fait currency makes sense. However, one needs to recognize that a greater fool theory game is at work, requiring quick sales to avoid losses.) We don’t have enough history and court cases to determine whether crypto related assets are better.

Where Are We Today

We have had a remarkably productive ten years in the market, but recently there has been great damage done to the ten-year performance records. (Unfortunately, my data does not include Friday’s painful numbers.) To over-correct in looking at the ten-year mutual fund performance record, I have eliminated peer groups gaining less than 10% per annum. 

I found 17 peer group averages that produced compound growth rates from 10% to 16.96%.  They are listed alphabetically below:

Capital Appreciation   Global Real Estate

Consumer Goods         Health/Biotech 

Consumer Services      India Region

Energy MLP             Micro-Caps 

Equity Income          Mid-Caps 

European               S&P Index 

Financial Services     Science & Tech

Growth & Income        Small-Cap 

Global

I question whether many regional fund groups can continue better performance than selective global competitors for long periods. Past performance is a useful research screen but cannot be solely relied upon due to changing conditions.

One change due to both bank and market regulatory modifications is the level of trading desk liquidity. It is shrinking and depending on the size of the trading relationship, access is uncertain.

Another concern is the needs and desires of consumers conflicting with the political desire for jobs. Both European and US governments appear to prize job creation over consumer needs for the best products and prices. This trend aggravates supply shortages and causes unnecessary inflation

Unaddressed Trends Can be Problems

We have been told that demographics is destiny, yet we are not paying attention to the message it is sending. Liz Ann Sonders of Charles Schwab tweeted the following:

In 1952 the average global family had five children, now they have less than three. Following is the number of children per family in various countries: Niger 6.7, Nigeria 5.2, Senegal 4.5, Ghana 3.8, Pakistan 3.4, World 2.4, Mexico 2.1. The replacement rate in the US is 1.8 or lower and it’s 1.1 in South Korea (Within many people’s lifetime, India will have more people than the shrinking population of China. 

These numbers have long-term military, economic, and investment implications. What can be done about these trends?  One of the lessons from the US Marine Corps is to get the best possible troops on your side. Economically, the founders of Unicorns are the most productive people we have. (Unicorns are start-ups that become worth $1 billion or more.) The founders top 6 academic majors of these unicorn are in order:

Computer Science

Engineering

Business

Economics

Biology

Mathematics

Students who successfully take and complete these courses are used to precision and discipline. They learn at home or at an early age. We need more of these students to offset the eventual power of those growing societies.

Please Share Your Thoughts

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

https://mikelipper.blogspot.com/2022/06/mike-lippers-monday-morning-musings-how.html

https://mikelipper.blogspot.com/2022/05/bear-markets-recessions-not-inevitable.html

https://mikelipper.blogspot.com/2022/05/falling-confidence-beats-numbers-but-be.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

How Deep & How Long - Weekly Blog # 736

                                    

Mike Lipper’s Monday Morning Musings

How Deep & How Long

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

Concerns

Periods of low volume and relatively small moves are normally comforting and allow us to avoid making decisions. My biggest concern is that I may not see enough that is important and draw the wrong conclusions. 

As a contrarian and entrepreneur, I am normally at ease being lonely or a minority in my thinking. This approach has worked out reasonably well for me and my clients. I am increasingly concerned that several others, including some well-known leaders, are voicing similar concerns about the future of global markets and economies. Could we be talking ourselves into a bear market and recession?

Tea Leaves

The following are very brief comments largely from one of the most erudite market research departments in our business, Bank of America Global Research, supplemented by other insights:

1. The NASDAQ is up 11% from its May 20th lows, despite Brainard. (The Fed has flip-flopped back to hawkish), JOLTS were strong not weak, oil was up not down, there were CEOs pessimistic, Microsoft gave lower guidance, and Moody’s gave no guidance at all.
2. Oil prices are annualizing a 108% gain, surpassed only in ’99 during the TMT bubble and during the ’74 oil shock.
3. Will it be the Summer of Volcker, with the central banks just getting started and a “no fun” Fed till done?
4. Popularity of corporate high yield by issuers and investors.
5. Private clients want yield, quality, and growth defensives, in that order
6. The Bank of America Bull & Bear Indicator moved to extreme bearish, the lowest signal since June 20. (Even though brokerage commissions are currently small, transaction activity is good for brokerage firms.)
7. NASDAQ bears are ending as Quantitative Trading begins
8. Global food prices were up 30% for the past 12 months. Housing prices globally are sharply higher. For many, the increase in the “value” of their home equals their annual working income. Inflation is rising much faster than wages. We have the highest ratio of vacancies to “unemployed”. (Remember, some with “off the books income” are counted as unemployed).
9. Shadow banking’s strength through an economic decline can be questioned and may be expensive for the economy and borrowers.
10. There are some who believe the bottom has already been reached and tested. (Doesn’t seem correct)

My review of Barron’s weekly data I found of interest:

1.  While the number of shares traded on the NYSE and NASDAQ was similar, more shares were sold than bought for the week in each case. There was a distinct difference in the frequency of new highs and new lows on the two markets:

           # New Highs   #New Lows   # Listed

    NYSE        155         112         3611

    NASDAQ       64          38         5470

As the NASDAQ attracts a greater percentage of professional speculators, one might conclude that the week’s volume was generated more from public investors and wealth managers than public investors directly.

2.  This focus on the strength of the NYSE comes at the very time equal weighted performance indices are performing better than capital weighted. This is true for the S&P 500 and for 9 out of 11 sectors.

3.  The weekly summary of the American Association of Individual Investors (AAII) survey is a contrary indicator of market turning points. This week’s survey moved away from its extreme readings to a more neutral position, 32%/37% respectively.

Mutual Funds

The weekly performance of mutual funds often describes the forces driving the US markets. The table below shows the only 4 fund peer groups which gained 5% for the week ended Thursday, along with their performance for the latest 52-weeks and 5 years:

Peer Group        Week    52 Weeks   5 Years

Equity Leverage  +5.92%    -15.14%     +5.62%

China Region     +5.71%    -31.07%     +3.92%

Global Tech      +5.66%    -24.47%    +13.42%

Science & Tech   +5.46%    -16.01%    +15.15%

While the week’s performance leaders were close together, they were recovering from quite different depths. Additionally, the performance rank within group was a reversal of the performance for five years. This suggests short term performance is not indicative of long-term performance. I am a little surprised that the advantage of leveraged performance was not greater. The spread between the Global Tech Fund average and the more domestic Science & Tech Funds may be a function of the relative strength of the dollar, which is unlikely to continue indefinitely. 

Important 

The recent rise in the China Region reflects a recovery from Chinese lockdowns and an apparent change of attitude in Chinese political leadership. The last observation is worth following closely. We are seeing more tensions between President Xi and Premier Li Keqiang. There are several political factions within the CCP and most need to be allied with Xi for him to win an unprecedented third term. There will quite likely be some horse trading between factions, which may impact the attractiveness of investing in Chinese securities/funds, as well as in world trade.

Warnings

JP Morgan Chase and Goldman Sachs are the big leaders in global M&A facilitation and investment banking. Both the President of Goldman, John Waldron, and the Chair of JP Morgan Chase have issued warnings about difficult times ahead.

Inflation and Shortages

Evidently, we have been told there is disagreement within The White House and possibly some Cabinet members on how to address the rising level of inflation, believed to be caused by shortages. Some wish to stop price increases by lowering the demand bidding up prices. However, the way to lower prices is by increasing supply. 

At least half of current inflation could be reversed by withdrawing our restrictive energy policies and by reducing tariffs to help our lower earning population. 

Shortages beget other shortages and misplace consumer, industrial, and investment allocations. 

Election Bet

While the 2024 Presidential election is two years away, it is an appropriate time to guess its outcome and impact on investment portfolios. The general view is the 2024 election will be a re-run of 2020. If it were to be, then my guess is the election will turn on the political skills of the Vice-Presidential candidates, who will do more of the heavy lifting. The bet becomes more interesting if only one of the previous two candidates runs, as he and his party will likely lose. My best guess is congressional and big city leaders have too much to lose and will force some changes.

If there is not much progress addressing US problems, whoever wins in 2024 will win a “poisoned chalice”, as most of their time and effort will be spent attempting to rectify leftover problems. As someone who has invested in turnarounds, I believe a reasonably complete turnaround will take at least five years. 

From an investor’s viewpoint, this unhappy set of circumstances suggests the period will be marked by relatively low returns in the mid-high single digits. These results will permit many to retire carefully, but not with a cushion for emergencies or estates to pass onto children.

Please share your views. 

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

https://mikelipper.blogspot.com/2022/05/falling-confidence-beats-numbers-but-be.html

https://mikelipper.blogspot.com/2022/05/inconclusive-but-trending-lower-weekly.html

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

Did someone forward you this blog? 

To receive Mike Lipper’s Blog each Monday morning, please subscribe by emailing me directly at AML@Lipperadvising.com

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.