In my continuing search to locate the missing buyers that are needed to put the stock market on a higher plane, I have learned from others the expressed view that it is too painful to buy more when one has not broken even. Emotionally I understand this. One does not want to go through a breakup, either of a personal relationship or a firm, but often that is required before moving on to the next phase or new relationships. One of the reasons to avoid breaking up is the desire not to unduly hurt other parties. Often this means staying in an unhappy relationship too long for all involved. In a somewhat analogous way, holding on to securities or perhaps investable cash can hurt. But in these cases the hurt is to the investor and possibly the beneficiaries.
AFTER-TAX CONSIDERATIONS
Whether an investment is to be successful is a function of future prices, either in absolute or relative terms. Unlike human relationships which are based somewhat on the conditions of the participants when they enter a relationship, stock prices don’t remember your entry prices. Only the tax collector primarily cares whether your transactions produce a net profit or a loss and over what length of time between purchase and sale dates. One of the many errors people make is that they carry their investments at current prices. Since we have been told that the only certainties in life are death and taxes, we should carry our assets net of expected income and/or estate taxes. One of the curious things that happens when a purported price rises above our purchase price is that we might consider it goes from a usable tax loss to an incipient tax liability. Neither condition should heavily influence investor actions. In this case, unlike human behavior/memory, the future will not be determined by our past.
MORE MODEST VALUATIONS
Freeing up investment capital for better investment is the essence of sound investment activity. While we are struggling today with the unknowns of future stock prices, we can easily believe that some prices will grow faster than others. In a vast oversimplification, future relative stock prices will be a function of how rapidly corporations will grow their businesses and what relative change the market places on its collective valuation. This philosophy leads one in the direction of selecting improving companies with more modest valuations, a difficult combination to find. (We hope, on balance, the portfolio managers we have selected for clients do a reasonably good job of selections for the various futures.)
At the current levels in the stock market, one would think that many stock prices do not represent a positive future valuation even if they do improve as one might expect. These stock prices compare with some of those that we own that are good companies with not much chance for above-average improvement. Therefore, some switching appears in order for a number of positions.
By the way, if one is to be truly analytical, positions should be viewed in terms of the real dollar level at the time of purchase. Thus many of the gains that we hold are not up as much as we believe. If you believe as I do, that on a long term basis the purchasing power of the dollar will decline, to maintain your standard of living you need to find investments that will grow faster than the dollar’s purchasing power decline.
ADDITIONAL CONSIDERATIONS
In the past, mutual fund investors often redeemed their shares when they had broken even. In most cases they defined breaking even as when the net asset value currently quoted to them was higher than their remembered purchase price. Again, from an analytical viewpoint this calculation is misleading. Over time they have received income and hopefully capital gains distributions, plus in some cases return of capital distributions. These should be added back to the initial price if one wants to compare the performance of the fund versus some stock prices. Another add-back should be the sales costs, management costs and administrative expenses paid. That some of these costs did not produce the intended results is immaterial in that they were paid by the fund investor. Thus, often fund investors have done relatively better than they thought.
Bottom line: do not let the fear of the tax collector put your holdings in a “quasi-tax jail.” Be among the early-renewed buyers of potential future winners. When the other buyers catch-up to you, they will probably be paying higher prices.
__________________________________________
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.
Sunday, June 27, 2010
Sunday, June 20, 2010
Unpredictability and My Grandfather
Often in these blogs I use inputs from beyond the US, and I will again tonight. My reasoning is that we live in a closed cycle on this singular earth, where important events anyplace can have significant impact on the portfolios that I manage for wealthy people and institutions. I did not realize that some of the members of this blog community tap into us occasionally from the United Kingdom, Hong Kong, Philippines, Australia, Canada, France, Russia, Germany and Denmark. Just as those within the US, people elsewhere invest externally to escape the constraints imposed by their own governments and look for opportunities elsewhere. Further, we have seen that basic investment principles, or if you will wisdom, regularly jumps borders. Hopefully, all of the members of this blog community will perceive some worthwhile insights from these blogs.
In discussing what to write about for this blog during my Father’s Day call with one of my sons, he suggested a good topic might be the wisdom I received from my grandfather. Most of my investment conversations with my grandfather were when I was a couple of years either side of ten. These discussions were many years after he retired as the senior partner of his own brokerage firm that served the “carriage trade.” I am sure that he had many wise things to say, but only two were germane to investments of today.
CREDIT CRUNCH IN THE 1930s
The first discussion referred to the 1930s, when at times one could not borrow money even if you had substantial cash in a safe deposit box. He recognized that the inability to borrow would be crippling to his brokerage firm (that he successfully liquidated) as well as to his wealthy clients who used margin borrowing. The second thing that I took away from his statement was that he did not totally trust banks for all of his deposits. I wish that he would have been around in 2008 so we could have discussed the liquidity crisis that took down two of the brokerage firms he competed with, Bear Stearns and Lehman Brothers.
OIL DEPLETION ALLOWANCE
The second insight that I learned from him was the importance of tax accounting for the oil companies. He felt that the then sizeable depletion allowances gave the oil companies what Warren Buffet would recognize in the insurance business as “float.” Depletion was one way to have the oil companies focus on the replacement cost of the oil they were pumping. Oil company replacement cost accounting, while not generally the focus of stock investors, drives a number of the large oil companies today. This is why a number of the majors spend all of their prodigious cash flow in exploration and borrow outside capital to pay their dividends which are critical to support their stock prices. One can see the implications for the shareholders of BP of this type of analysis, but we would leave that to others for the moment.
CONTINUITY OF WISDOM
The reason to bring up the wisdom of my grandfather is to illustrate that one of the better ways wealthy families survive is not just cash preservation, but by passing on sound principles to their families. Capital can be lost to bad investment decisions or consumed through high expenses. Analytically sound thinking can aid in the family’s recovery of their wealth. We have seen this often when formerly wealthy families are forced to leave their homelands and begin anew in a foreign land. Relying on hard work and passed-on principles, they recover and prosper. One of the jobs of wealth managers and family officers is not just preserving wealth, but helping future generations learn from their parents and grandparents how to make money in the future.
UNPREDICTABILITY
One of the ways to learn about the financial world that is both different, but in many ways similar to my grandfather’s time, is to read important articles and books. For readers, one of the major pluses of Rupert Murdock’s purchase of Dow Jones is that he can introduce us to some of the best thinking in the London press. In Saturday’s Wall Street Journal an article on the unpredictability of the future, entitled “The Benefits of the Bust,” was written by Anatole Kaletsky, editor at large of The Times of London, (click here to read) This article dwells on the fact that once again we were unprepared for the future. The various economic and political models did not contemplate wholesale disruption of what were perceived to be known: housing prices and the failure of very large financial institutions. I recommend that you read this piece and contemplate it in terms of the unpredictability of the future. Yet as people and particularly business people, we must spend money today against some concept of what the future will hold. These are important lessons for those who have the responsibility of investing money today for the future benefit of others.
Perhaps on this Father’s Day we should think carefully about how to apply the lessons of our fathers and grandfathers to today’s problems and opportunities. I, for one, am convinced that my grandfather would have been a success in today’s environment. I only hope to have learned from him and others to do as well.
Happy Father’s Day
_________________________________________
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.
In discussing what to write about for this blog during my Father’s Day call with one of my sons, he suggested a good topic might be the wisdom I received from my grandfather. Most of my investment conversations with my grandfather were when I was a couple of years either side of ten. These discussions were many years after he retired as the senior partner of his own brokerage firm that served the “carriage trade.” I am sure that he had many wise things to say, but only two were germane to investments of today.
CREDIT CRUNCH IN THE 1930s
The first discussion referred to the 1930s, when at times one could not borrow money even if you had substantial cash in a safe deposit box. He recognized that the inability to borrow would be crippling to his brokerage firm (that he successfully liquidated) as well as to his wealthy clients who used margin borrowing. The second thing that I took away from his statement was that he did not totally trust banks for all of his deposits. I wish that he would have been around in 2008 so we could have discussed the liquidity crisis that took down two of the brokerage firms he competed with, Bear Stearns and Lehman Brothers.
OIL DEPLETION ALLOWANCE
The second insight that I learned from him was the importance of tax accounting for the oil companies. He felt that the then sizeable depletion allowances gave the oil companies what Warren Buffet would recognize in the insurance business as “float.” Depletion was one way to have the oil companies focus on the replacement cost of the oil they were pumping. Oil company replacement cost accounting, while not generally the focus of stock investors, drives a number of the large oil companies today. This is why a number of the majors spend all of their prodigious cash flow in exploration and borrow outside capital to pay their dividends which are critical to support their stock prices. One can see the implications for the shareholders of BP of this type of analysis, but we would leave that to others for the moment.
CONTINUITY OF WISDOM
The reason to bring up the wisdom of my grandfather is to illustrate that one of the better ways wealthy families survive is not just cash preservation, but by passing on sound principles to their families. Capital can be lost to bad investment decisions or consumed through high expenses. Analytically sound thinking can aid in the family’s recovery of their wealth. We have seen this often when formerly wealthy families are forced to leave their homelands and begin anew in a foreign land. Relying on hard work and passed-on principles, they recover and prosper. One of the jobs of wealth managers and family officers is not just preserving wealth, but helping future generations learn from their parents and grandparents how to make money in the future.
UNPREDICTABILITY
One of the ways to learn about the financial world that is both different, but in many ways similar to my grandfather’s time, is to read important articles and books. For readers, one of the major pluses of Rupert Murdock’s purchase of Dow Jones is that he can introduce us to some of the best thinking in the London press. In Saturday’s Wall Street Journal an article on the unpredictability of the future, entitled “The Benefits of the Bust,” was written by Anatole Kaletsky, editor at large of The Times of London, (click here to read) This article dwells on the fact that once again we were unprepared for the future. The various economic and political models did not contemplate wholesale disruption of what were perceived to be known: housing prices and the failure of very large financial institutions. I recommend that you read this piece and contemplate it in terms of the unpredictability of the future. Yet as people and particularly business people, we must spend money today against some concept of what the future will hold. These are important lessons for those who have the responsibility of investing money today for the future benefit of others.
Perhaps on this Father’s Day we should think carefully about how to apply the lessons of our fathers and grandfathers to today’s problems and opportunities. I, for one, am convinced that my grandfather would have been a success in today’s environment. I only hope to have learned from him and others to do as well.
Happy Father’s Day
_________________________________________
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.
Sunday, June 13, 2010
Too Much Focus on Short Term Imponderables,
Not Enough on Long Term Challenges and Opportunities
Unfortunately almost all attention is focused on the short to intermediate time horizons during this period when there is no sustained progress investing in large cap domestic stocks. These horizons are set by the patience of the most impatient member of each of our formal or informal investment committees. I noticed how conversations focus on the latest morsel of very current information, as if this will provide the answers to our long term investment needs.
MY WEEKEND READING “MORSELS”
All of the above elements are indicating that we are in a more normal or even a “new normal” period.
For my clients, family and the institutional investment committees that I serve, I try to focus on long term needs. Additional inputs that contribute to my long-term thinking are:
INPUTS FOR THE LONGER-TERM
I maintain all of the above items are tactically important and are descriptive of the present moods. I would daresay that a consensus has been formed that the current markets do not offer any major opportunities to meet long term needs through investment gains.
BETTING ON NON-FAVORITES
My training at handicapping thoroughbred race horses holds that favorites, by definition consensus chosen, may win about a third of the time. When they do, the rewards are not enough to pay for the other losing tickets and their imbedded fees and taxes. The only to win money on balance is to selectively pick non-favorites. Almost by definition this process works on a different set of conditions occurring than those that have bet on the favorites.
THREE TENETS THAT LEAD TO CHANGE
I believe that future conditions which could start at any time will be viewed differently than those of today. As usual in these tautologies my beliefs are based on three growing forces. The first is innovation and technology. My Caltech bias may be showing, but long before joining their board I was a reasonably good electronics analyst. The second force is demographics as the growth both in numbers and drive for higher standards of living will raise the aggregate level of demand and to some degree where the supply will originate. (For the most part the countries in the northern hemisphere are facing a demographic time bomb of having too few workers to pay for those who are retired. The US is on the cusp of such dilemma. Our way out is to encourage the right sort of immigration and education.) The third force is very difficult: discipline. I have little faith in so-called reform measures imposed by governments without getting their own houses in order. I do believe that many people including business people, investors and loan officers have recognized some of their prior enthusiasm has led to bad decisions. Similarly, some of the losing teams in the World Cup will go home with an understanding that good intentions are not enough without the proper training and on-field discipline.
FOR INVESTMENT COMMITTEES:
The question before the formal and informal investment committees is how to structure for this expected change in conditions. Recently, I have advocated for a significant non-profit that the endowment be divided into three unequal parts. The first is to fund the current year’s needs as well as the next years’. (In other words, if the investment world collapses you have at least two years to live.) The second and the largest piece is to invest to meet the identified needs; which could be new facilities or sending Johnny to college. The third piece is to invest the needs beyond the identified horizon. We all have experience in our lives, both challenges and opportunities, that we did not expect. With the correct mind-set and a little bit of capital, these challenges can be opportunities. I will be the first to admit this three element strategy is easier to manage through the use of mutual funds or specifically designed separate accounts, than by choosing individual securities.
I am curious as to the reactions, comments and criticisms from the members of this Blog’s community, please let me know your thoughts.
_________________________________________
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.
MY WEEKEND READING “MORSELS”
- Chase is marketing a CMBS structured offering with a bottom traunch that has no credit rating and will be sold to hedge funds or swallowed themselves.
- CDO spreads show our fear levels, with Citi being at 327 bps, Goldman Sachs at 260, and JP Morgan at 138.
- Last week the Australian dollar rose vs. the US dollar 3.1%, the Canadian dollar 2.8%, the New Zealand dollar 2.75% and the Swiss franc 1.3%.
- The Barron’s Confidence Index (mentioned last week as an unusually bullish indicator) dropped some of the way back to its prior level.
- The Wall Street Journal suggested this is a time to use leverage.
All of the above elements are indicating that we are in a more normal or even a “new normal” period.
For my clients, family and the institutional investment committees that I serve, I try to focus on long term needs. Additional inputs that contribute to my long-term thinking are:
INPUTS FOR THE LONGER-TERM
- The state of Colorado after using a future investment returns assumption of 8.5% has recognized that if they lower their assumption to a somewhat more reasonable 7%, they will run out of money to pay pensions in 30 years.
- Jason Zweig in his always important but often controversial column in the Weekend edition of the WSJ (click here to read) compares the current difficulty of the DJIA to sustain a reading over 10,000 over the last ten years to the sixteen year period it took the index to sustainably rise over the 1000 level.
- Last year for the first time in perhaps thirty years, investors bought more gold than the jewelry trade. I have read that one gold ETF owns more gold in one London vault than all but a few central banks. Diamonds are also in significant demand. A high end Jeweler told me that he is having difficulty in obtaining serious diamonds caused in part by De Beers' control of the market. I also learned that in the US the retail price per carat is about $200, and in China over $1000.
- There is a new study that that suggests after a 10 year bull market in commodities, a 20 year bear market follows. (This makes sense to me in that higher prices bring into productions new mines and a major rise in capital expenditures, which we are seeing now.)
I maintain all of the above items are tactically important and are descriptive of the present moods. I would daresay that a consensus has been formed that the current markets do not offer any major opportunities to meet long term needs through investment gains.
BETTING ON NON-FAVORITES
My training at handicapping thoroughbred race horses holds that favorites, by definition consensus chosen, may win about a third of the time. When they do, the rewards are not enough to pay for the other losing tickets and their imbedded fees and taxes. The only to win money on balance is to selectively pick non-favorites. Almost by definition this process works on a different set of conditions occurring than those that have bet on the favorites.
THREE TENETS THAT LEAD TO CHANGE
I believe that future conditions which could start at any time will be viewed differently than those of today. As usual in these tautologies my beliefs are based on three growing forces. The first is innovation and technology. My Caltech bias may be showing, but long before joining their board I was a reasonably good electronics analyst. The second force is demographics as the growth both in numbers and drive for higher standards of living will raise the aggregate level of demand and to some degree where the supply will originate. (For the most part the countries in the northern hemisphere are facing a demographic time bomb of having too few workers to pay for those who are retired. The US is on the cusp of such dilemma. Our way out is to encourage the right sort of immigration and education.) The third force is very difficult: discipline. I have little faith in so-called reform measures imposed by governments without getting their own houses in order. I do believe that many people including business people, investors and loan officers have recognized some of their prior enthusiasm has led to bad decisions. Similarly, some of the losing teams in the World Cup will go home with an understanding that good intentions are not enough without the proper training and on-field discipline.
FOR INVESTMENT COMMITTEES:
The question before the formal and informal investment committees is how to structure for this expected change in conditions. Recently, I have advocated for a significant non-profit that the endowment be divided into three unequal parts. The first is to fund the current year’s needs as well as the next years’. (In other words, if the investment world collapses you have at least two years to live.) The second and the largest piece is to invest to meet the identified needs; which could be new facilities or sending Johnny to college. The third piece is to invest the needs beyond the identified horizon. We all have experience in our lives, both challenges and opportunities, that we did not expect. With the correct mind-set and a little bit of capital, these challenges can be opportunities. I will be the first to admit this three element strategy is easier to manage through the use of mutual funds or specifically designed separate accounts, than by choosing individual securities.
I am curious as to the reactions, comments and criticisms from the members of this Blog’s community, please let me know your thoughts.
_________________________________________
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.
Sunday, June 6, 2010
The Buyers’ Strike May Continue;
Was Friday a Clue?
On Friday, June 4, the Dow Jones Industrial Average declined 323.31 points or 3.15%, with most of the damage occurring early in the day. The volume of reported transactions was only marginally above what is now passing for normal. In the past, major declines brought out “buy on the dips” volume, however not this time. Was this a sign that something fundamental was happening that had longer term implications? Let’s look at three news items that came out on Friday (or after the close on Thursday) and their possible implications.
A WAKE-UP CALL?
The new government of Hungary let it be known that the prior government’s statistics were so faulty that the country’s debt probably can not be supported without a devaluation of its currency, and therefore an induced inflation. The significance to investors in euros and US dollars was that this announcement might prompt us to raise a mirror to our own growth of government debt and a constrained economy. Hungary’s way out is its own currency. In effect Hungary, like Lehman and Bear Stearns, has access to capital markets. The countries collectively known as the “PIIGS” (Portugal, Italy, Ireland, Greece and Spain) do not have that option, at least for the moment they are trapped along with their richer neighbors in the single currency. The way out for the US (as the de facto world reserve currency) is induced inflation. Was this a wake-up call challenging those who feel that the problems in Greece, Portugal and Spain were being attended to, and the US would grow its way out of problems?
BANKS AND RETAIL BROKERS NOT LEADING THE MARKET
Also late on Thursday there were two unrelated news elements that brought additional concerns about the global financial community. The first was the rumor that Société Générale had suffered large derivative-related losses, which on Friday they denied. The key to the market was not that the French bank suffered trading losses, but rather that it and other banks could lose big. After the close in the US, it was announced that the president of Wilmington Trust unexpectedly announced his retirement. He is to be replaced as president by an internal candidate with corporate experience who has headed up Wilmington’s non-lending activities. Once again a bank is being led by a non-banker, similar to CEOs at JPMorgan Chase (a stockbroker), Bank of America (a lawyer) and Citigroup (a hedge fund manager). Tying these two elements together, are we projecting that banks will not make deposit gathering and lending their main source of future profits, but instead will rely on trading and other forms of investing to generate dividends for their various shareholders? Is this alternative being severely curtailed by the so-called reform measures in the conference committee of the US Congress which will put US financial institutions behind the less capitalized foreign universal banks? At this point in the cycle commercial banks and retail brokerage firms should be in a market leadership position and they are not today.
A PALPABLE LACK OF RETAIL CONFIDENCE
The third bit of bad news that hit on Friday was the extremely weak private sector jobs report. One could chalk the disappointment off to the “abysmal science” of the economists. Economists’ US estimates were way high and they were low in Canada, where job growth was twice what was expected and its unemployment rate dropped to 8.1%. There is a suspicion on my part that the economists and some analysts are not mall walkers, having under-estimated the Canadian market and over-estimated the US retail sector. The lack of confidence on the part of stores hiring retail sales people is palpable. There are still too many empty store fronts to support a growing economy. Part of the issue is that now with the bulk of the aggregate stimulus packages spent, our money supply is contracting. This is not a surprise to our government. Treasury Secretary Geithner has warned the other members of the G-20 that the “US can no longer absorb the world’s exports.”
ADDITIONAL INPUTS
How is all of this being translated into investment policies? There are additional inputs that might be useful in your own investment thinking,
The first is volatility. Notice that the press is full of stories about volatility primarily on down days. Few seem to worry about volatility on the upside. Part of this may be due to the harm that many financial academics have done to investing by equating volatility with risk. This is discussed more fully in my book Money Wise. The CBOE Volatility Index (VIX) is a popular measure of volatility (that few people really understand) which tracks the “bets” on the S&P500 contracts. When the number is high the “fear” indicator is high. The historic high on the index was approximately 80 and the low achieved a few months ago was about 15. On Friday the index rose 6.02 to 35.48, a one day gain of 20.43%. I believe that on May 6th the index was over 45. I would suggest in recognition of the fact that so many of the market participants are trading oriented that one needs to be prepared for volatility in today’s ranges. This translates that on most days we could see moves of 100-200 Dow Jones points. Expect this level of volatility as you manage your transactions.
As is often the case, the US bond market often is more sensitive to future trends than the stock market. Each week Barron’s publishes its confidence index which measures an index of high grade bonds divided by an index of intermediate grade bonds. A decline in the latter vs. the former generally points to higher stocks. In other words, as the yields on intermediate credit declines relative to high grade, their prices go up (which is often paralleled by more confidence in stocks). As an observer of this index for more than 40 years, I am used to seeing weekly moves of 1 point or less. For the week that just ended the reading was 79.0 up from the prior week reading of 75.2. A year ago the number was 68.7. While this indicator is far from infallible, it has produced winning judgments more often than not. I choose to be encouraged by this particular confidence indicator.
A LONGER TERM PERSPECTIVE
One has to have a strong contrarian point of view and a belief in institutional fallibility. The trend of leading pension plans to invest into commodities is growing. CALSTRS is joining CALPERS and the teacher plans in Texas and Illinois, as well BT from Britain and two Dutch pension plans in making specific allocations to commodities. I interpret these as long term bets on increased inflation caused by the deterioration of the value of money’s purchasing power. If these are more than a simple hedge, but a bet on institutionalized inflation, then one wonders whether long term bonds have any place in one’s investment portfolio. Stocks may not do well under these circumstances, but are clearly better than bonds. Many corporate pension plans are very much betting the other way, significantly switching equity money into corporate bonds. Both the government and corporate plans are reacting to their fears not to opportunities, which in the long run makes me bullish for our long horizon investment accounts.
_________________________________________
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 WAKE-UP CALL?
The new government of Hungary let it be known that the prior government’s statistics were so faulty that the country’s debt probably can not be supported without a devaluation of its currency, and therefore an induced inflation. The significance to investors in euros and US dollars was that this announcement might prompt us to raise a mirror to our own growth of government debt and a constrained economy. Hungary’s way out is its own currency. In effect Hungary, like Lehman and Bear Stearns, has access to capital markets. The countries collectively known as the “PIIGS” (Portugal, Italy, Ireland, Greece and Spain) do not have that option, at least for the moment they are trapped along with their richer neighbors in the single currency. The way out for the US (as the de facto world reserve currency) is induced inflation. Was this a wake-up call challenging those who feel that the problems in Greece, Portugal and Spain were being attended to, and the US would grow its way out of problems?
BANKS AND RETAIL BROKERS NOT LEADING THE MARKET
Also late on Thursday there were two unrelated news elements that brought additional concerns about the global financial community. The first was the rumor that Société Générale had suffered large derivative-related losses, which on Friday they denied. The key to the market was not that the French bank suffered trading losses, but rather that it and other banks could lose big. After the close in the US, it was announced that the president of Wilmington Trust unexpectedly announced his retirement. He is to be replaced as president by an internal candidate with corporate experience who has headed up Wilmington’s non-lending activities. Once again a bank is being led by a non-banker, similar to CEOs at JPMorgan Chase (a stockbroker), Bank of America (a lawyer) and Citigroup (a hedge fund manager). Tying these two elements together, are we projecting that banks will not make deposit gathering and lending their main source of future profits, but instead will rely on trading and other forms of investing to generate dividends for their various shareholders? Is this alternative being severely curtailed by the so-called reform measures in the conference committee of the US Congress which will put US financial institutions behind the less capitalized foreign universal banks? At this point in the cycle commercial banks and retail brokerage firms should be in a market leadership position and they are not today.
A PALPABLE LACK OF RETAIL CONFIDENCE
The third bit of bad news that hit on Friday was the extremely weak private sector jobs report. One could chalk the disappointment off to the “abysmal science” of the economists. Economists’ US estimates were way high and they were low in Canada, where job growth was twice what was expected and its unemployment rate dropped to 8.1%. There is a suspicion on my part that the economists and some analysts are not mall walkers, having under-estimated the Canadian market and over-estimated the US retail sector. The lack of confidence on the part of stores hiring retail sales people is palpable. There are still too many empty store fronts to support a growing economy. Part of the issue is that now with the bulk of the aggregate stimulus packages spent, our money supply is contracting. This is not a surprise to our government. Treasury Secretary Geithner has warned the other members of the G-20 that the “US can no longer absorb the world’s exports.”
ADDITIONAL INPUTS
How is all of this being translated into investment policies? There are additional inputs that might be useful in your own investment thinking,
The first is volatility. Notice that the press is full of stories about volatility primarily on down days. Few seem to worry about volatility on the upside. Part of this may be due to the harm that many financial academics have done to investing by equating volatility with risk. This is discussed more fully in my book Money Wise. The CBOE Volatility Index (VIX) is a popular measure of volatility (that few people really understand) which tracks the “bets” on the S&P500 contracts. When the number is high the “fear” indicator is high. The historic high on the index was approximately 80 and the low achieved a few months ago was about 15. On Friday the index rose 6.02 to 35.48, a one day gain of 20.43%. I believe that on May 6th the index was over 45. I would suggest in recognition of the fact that so many of the market participants are trading oriented that one needs to be prepared for volatility in today’s ranges. This translates that on most days we could see moves of 100-200 Dow Jones points. Expect this level of volatility as you manage your transactions.
As is often the case, the US bond market often is more sensitive to future trends than the stock market. Each week Barron’s publishes its confidence index which measures an index of high grade bonds divided by an index of intermediate grade bonds. A decline in the latter vs. the former generally points to higher stocks. In other words, as the yields on intermediate credit declines relative to high grade, their prices go up (which is often paralleled by more confidence in stocks). As an observer of this index for more than 40 years, I am used to seeing weekly moves of 1 point or less. For the week that just ended the reading was 79.0 up from the prior week reading of 75.2. A year ago the number was 68.7. While this indicator is far from infallible, it has produced winning judgments more often than not. I choose to be encouraged by this particular confidence indicator.
A LONGER TERM PERSPECTIVE
One has to have a strong contrarian point of view and a belief in institutional fallibility. The trend of leading pension plans to invest into commodities is growing. CALSTRS is joining CALPERS and the teacher plans in Texas and Illinois, as well BT from Britain and two Dutch pension plans in making specific allocations to commodities. I interpret these as long term bets on increased inflation caused by the deterioration of the value of money’s purchasing power. If these are more than a simple hedge, but a bet on institutionalized inflation, then one wonders whether long term bonds have any place in one’s investment portfolio. Stocks may not do well under these circumstances, but are clearly better than bonds. Many corporate pension plans are very much betting the other way, significantly switching equity money into corporate bonds. Both the government and corporate plans are reacting to their fears not to opportunities, which in the long run makes me bullish for our long horizon investment accounts.
_________________________________________
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.
Monday, May 31, 2010
On Memorial Day,
and the Future Leaders of the
Investment Community
On this Memorial Day weekend my first thoughts turn to the ordinary people who have been our extraordinary heroes and heroines, who gave their lives and bodies so that we can be free of imposed dictatorships. One of the characteristics of wars and most conflicts is that they are battles between offense and defense. Rarely can one succeed without relying on both sets of skills.
CAPITAL WARS
As I write this blog, I am exercising my freedom to think about the war for the survival of our investment capital. Military wars have alternating offensive and defensive phases which often pivot on the success or failure of both new technology and more importantly, new applications of human behavior. Think about the language in the press, quoting many participants throughout 2008 and during this month of May, 2010. Frequently one reads about someone saying that they were “killed” or “mauled” by the fall in the market, and more recently by sharp spikes. The terms of war appear to be appropriate in describing this battle for the survival of our investment capital.
LEADERSHIP
Wars are won and lost by exceptional leaders and by using resources more intelligently than the opposition. Often the battle leaders have something in their background that one can point to as common among them. There have been a couple of graduating classes at West Point "where the stars fell." The leaders (generals) from these classes led us through our bloodiest wars. I had the distinct honor and good luck myself to be the member of an extraordinary class in the US Marine Corps’s Basic Officers Class. Out of a class of six hundred peacetime Marines, we had six members who became general officers, including a future Commandant and another four star general. (I believe that this was the first time the Corps had two four star generals at the same time.) In addition to the military success story, my class also included a number of very successful civilians in many walks of life. With this as a background, the members of this blog community will not be surprised to learn that I have been an analyst of leadership for most of my adult life.
BOND MANAGERS
As the background of leaders change, so does the way battles are fought. Until recently, the investment leaders were either solid, surviving investors or were salespeople who could deliver good investments. Since the 1930s the Bible for professional investors has been Graham & Dodd’s Security Analysis. I had the distinct honor to study under Professor David Dodd, and more importantly, Warren Buffet studied with Ben Graham. The original text and the six later editions discussed the various ways to make sound investment decisions. To the best of my recollection there was nothing about how to place or execute securities transactions. For the next couple of generations, equity analysts trained to become portfolio managers, who gave buy and sell orders on the various stock exchanges to “clerks” to execute. Over time these so-called “clerks” became professionals in their own right and some were admitted to ownership of their firms. As is often the case, the bond market was ahead of the stock market. Bond portfolio managers sat on the fixed income trading desks. Bonds trade largely in the over-the-counter market of occasional limited liquidity and discontinuance prices. Bond portfolio managers added or subtracted value due to their trading skills. As a student of fund performance I have seen that the relative performance results of a bond manager has more to do with making correct trading decisions than correctly anticipating interest rate moves.
RISE OF TRADING
In response to the growing professionalization of trading beginning in the 1990s, I started to see the hiring of traders as portfolio managers initially by and for hedge funds. These traders were often well trained at various hedge funds and proprietary desks of brokerage firms. In a vast over-simplification, the traders knew what was moving and they believed that a stock was only worth what it was selling for, not a discount from some future value. As these traders became more successful (and for political reasons the community was destroying the quasi-monopolistic power of its center), the skills of traders became more important. Various new market centers were created, both as exchanges and private markets. One of the keys to their success was the speed in which they could trade. The speed of trading depends on the speed of information transfer so trading technology has become critical.
TRADING OVER INVESTING
As the equity world woke up to this change (similar to surface ships recognizing the risk from torpedoes and aircraft), the intellectual leadership began to change. Instead of hiring liberal arts majors who could “think” and develop models of future values for companies, they hired PhDs with math and physics backgrounds. These “rocket scientists” from Caltech, MIT and Carnegie Mellon among other schools, became the bonus babies for “The Street.” (Bias is showing in that I am a trustee of Caltech, MIT bought mutual fund data from me years ago, and I have a freshman nephew at Carnegie Mellon.) The tasks of the rocket scientists were to determine the likely trajectory of the missile, (in this case, the next price) and intercept it for a brief moment. They were being wired to make very rapid, small, frequent gains or cutting their losses very quickly. As this kind of thinking became the dominant market leadership mode, I saw major changes in relative fund performance leadership. Due to the intraday induced volatility, trading added more than investing in many instances.
TWO EXAMPLES
Some great past performance leaders did not master the new art. I saw a similar thing happen in the market break in the late 1960s, where two performance leaders had similar spectacular performance on the way up and very different on the way down. While they owned similar and perhaps identical positions, the one that lost less sold his most liquid positions first. The lesser performing fund attempted to sell his most illiquid positions first. What is important in this leadership example is that in the subsequent recovery, the loser kept a significant cash reserve for the first time and the winner went back to his old, almost fully invested portfolio. In effect, the loser and his shareholders lost their nerve. In time the loser who still had some good performance retired and was replaced
NEW STARS...BUT OLD WAYS
I believe we have gone through at least one, if not multiple, inflection points and I expect the next new class which will have stars fall on its shoulders has graduated from law schools and is now getting into position to seek fortune. At this present time, we have about half the scenario for the next leadership battle. We already have, (and are getting more) data as to the instability in the marketplace. What is missing is the regulatory response. New national and international rules will be put into place that will attempt to fight the last battle. The rules will have all the benefit of the Pentagon’s past favorite practice: to fight the last war brilliantly on paper. They do not focus enough on how the future will build on the past.
MR. JOHNSON
The new rules will attempt to constrain various perceived ills. The constraints will add a level of complexity that will retard many. There will be some that will actually read the various regulations, and some more will understand the reporting technology put in place. By seeing things more bureaucratic minds will miss (the signs of a good lawyer), they will find new ways to make money. This will be not the first time that legal training led to investment success. One example, and there are many others, is “Mr. Johnson.” A Boston-based lawyer in the 1940s, Mr. Johnson had the opportunity to buy the ownership of one of his clients, which he renamed Fidelity Management & Research. Everyone including his son Ned referred to him as “Mr. Johnson.” For approximately thirty years it was his skill in seeing investment and marketing opportunities that others missed, that became the foundation of what Fidelity is today. He encouraged young associates to research stocks with same vigor as an attorney in preparation for an important case. He saw through regulations and practices that others didn’t.
What should we do now? We should be looking for new leadership to be our investment heroes, some will come from an understanding of the law.
_________________________________________
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.
CAPITAL WARS
As I write this blog, I am exercising my freedom to think about the war for the survival of our investment capital. Military wars have alternating offensive and defensive phases which often pivot on the success or failure of both new technology and more importantly, new applications of human behavior. Think about the language in the press, quoting many participants throughout 2008 and during this month of May, 2010. Frequently one reads about someone saying that they were “killed” or “mauled” by the fall in the market, and more recently by sharp spikes. The terms of war appear to be appropriate in describing this battle for the survival of our investment capital.
LEADERSHIP
Wars are won and lost by exceptional leaders and by using resources more intelligently than the opposition. Often the battle leaders have something in their background that one can point to as common among them. There have been a couple of graduating classes at West Point "where the stars fell." The leaders (generals) from these classes led us through our bloodiest wars. I had the distinct honor and good luck myself to be the member of an extraordinary class in the US Marine Corps’s Basic Officers Class. Out of a class of six hundred peacetime Marines, we had six members who became general officers, including a future Commandant and another four star general. (I believe that this was the first time the Corps had two four star generals at the same time.) In addition to the military success story, my class also included a number of very successful civilians in many walks of life. With this as a background, the members of this blog community will not be surprised to learn that I have been an analyst of leadership for most of my adult life.
BOND MANAGERS
As the background of leaders change, so does the way battles are fought. Until recently, the investment leaders were either solid, surviving investors or were salespeople who could deliver good investments. Since the 1930s the Bible for professional investors has been Graham & Dodd’s Security Analysis. I had the distinct honor to study under Professor David Dodd, and more importantly, Warren Buffet studied with Ben Graham. The original text and the six later editions discussed the various ways to make sound investment decisions. To the best of my recollection there was nothing about how to place or execute securities transactions. For the next couple of generations, equity analysts trained to become portfolio managers, who gave buy and sell orders on the various stock exchanges to “clerks” to execute. Over time these so-called “clerks” became professionals in their own right and some were admitted to ownership of their firms. As is often the case, the bond market was ahead of the stock market. Bond portfolio managers sat on the fixed income trading desks. Bonds trade largely in the over-the-counter market of occasional limited liquidity and discontinuance prices. Bond portfolio managers added or subtracted value due to their trading skills. As a student of fund performance I have seen that the relative performance results of a bond manager has more to do with making correct trading decisions than correctly anticipating interest rate moves.
RISE OF TRADING
In response to the growing professionalization of trading beginning in the 1990s, I started to see the hiring of traders as portfolio managers initially by and for hedge funds. These traders were often well trained at various hedge funds and proprietary desks of brokerage firms. In a vast over-simplification, the traders knew what was moving and they believed that a stock was only worth what it was selling for, not a discount from some future value. As these traders became more successful (and for political reasons the community was destroying the quasi-monopolistic power of its center), the skills of traders became more important. Various new market centers were created, both as exchanges and private markets. One of the keys to their success was the speed in which they could trade. The speed of trading depends on the speed of information transfer so trading technology has become critical.
TRADING OVER INVESTING
As the equity world woke up to this change (similar to surface ships recognizing the risk from torpedoes and aircraft), the intellectual leadership began to change. Instead of hiring liberal arts majors who could “think” and develop models of future values for companies, they hired PhDs with math and physics backgrounds. These “rocket scientists” from Caltech, MIT and Carnegie Mellon among other schools, became the bonus babies for “The Street.” (Bias is showing in that I am a trustee of Caltech, MIT bought mutual fund data from me years ago, and I have a freshman nephew at Carnegie Mellon.) The tasks of the rocket scientists were to determine the likely trajectory of the missile, (in this case, the next price) and intercept it for a brief moment. They were being wired to make very rapid, small, frequent gains or cutting their losses very quickly. As this kind of thinking became the dominant market leadership mode, I saw major changes in relative fund performance leadership. Due to the intraday induced volatility, trading added more than investing in many instances.
TWO EXAMPLES
Some great past performance leaders did not master the new art. I saw a similar thing happen in the market break in the late 1960s, where two performance leaders had similar spectacular performance on the way up and very different on the way down. While they owned similar and perhaps identical positions, the one that lost less sold his most liquid positions first. The lesser performing fund attempted to sell his most illiquid positions first. What is important in this leadership example is that in the subsequent recovery, the loser kept a significant cash reserve for the first time and the winner went back to his old, almost fully invested portfolio. In effect, the loser and his shareholders lost their nerve. In time the loser who still had some good performance retired and was replaced
NEW STARS...BUT OLD WAYS
I believe we have gone through at least one, if not multiple, inflection points and I expect the next new class which will have stars fall on its shoulders has graduated from law schools and is now getting into position to seek fortune. At this present time, we have about half the scenario for the next leadership battle. We already have, (and are getting more) data as to the instability in the marketplace. What is missing is the regulatory response. New national and international rules will be put into place that will attempt to fight the last battle. The rules will have all the benefit of the Pentagon’s past favorite practice: to fight the last war brilliantly on paper. They do not focus enough on how the future will build on the past.
MR. JOHNSON
The new rules will attempt to constrain various perceived ills. The constraints will add a level of complexity that will retard many. There will be some that will actually read the various regulations, and some more will understand the reporting technology put in place. By seeing things more bureaucratic minds will miss (the signs of a good lawyer), they will find new ways to make money. This will be not the first time that legal training led to investment success. One example, and there are many others, is “Mr. Johnson.” A Boston-based lawyer in the 1940s, Mr. Johnson had the opportunity to buy the ownership of one of his clients, which he renamed Fidelity Management & Research. Everyone including his son Ned referred to him as “Mr. Johnson.” For approximately thirty years it was his skill in seeing investment and marketing opportunities that others missed, that became the foundation of what Fidelity is today. He encouraged young associates to research stocks with same vigor as an attorney in preparation for an important case. He saw through regulations and practices that others didn’t.
What should we do now? We should be looking for new leadership to be our investment heroes, some will come from an understanding of the law.
_________________________________________
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.
Sunday, May 23, 2010
Unintended Consequences:
Investors Again Lose to the Politicians
Two quotes came to mind last week, the first was by New York Judge Gideon Tucker (sometimes attributed to Mark Twain): "No man’s life, liberty or property are safe while the Legislature is in session. The second was Will Rogers', “This country has come to feel the same when Congress is in session as when the baby gets hold of a hammer.”
We are about to watch the ultimate sausage manufacture of legislation, which continues a long line of unintended painful consequences to American investors, and much more importantly, to our economy. Soon there will be a conference committee named to resolve differences between the US Senate’s “Restoring American Financial Stability Act” and the House’s “Wall Street Reform and Consumer Protection Act.” As the various lobbyists and their dependent members of Congress write the new legislation (in which almost anything can show up), there is one almost guaranteed certainty. The ultimate result will not provide either meaningful stability or reform. This is not to say that there won’t be change. There are likely to be many changes, some large, drafted in the desire to help us avoid future problems similar to what we have suffered from over the last several years. Almost in a Newtonian fashion, the problem is that any legislative action will produce an opposite reaction by those beyond the Washington Beltway. If history is any guide, the unintended consequences will produce additional serious dislocations and risks to the soundness of investors and their retirement capital.
FEAR AND GREED
The legislation is an outgrowth of the clamoring by many “to do something” about the losses of capital, income, and most importantly, jobs. Unfortunately, changes in the rules of the game (like moving the goal posts in football), probably do not significantly alter the actions, ambitions, and the talents of the players for the most part. Throughout history, from Biblical times to the volatile trading of May 6, investors’ “animal instincts” drive people in the market place whether it is in the stock markets or the job markets. In a gross oversimplification, these are often summed up as fear and greed. (For those interested in these drivers, you may wish to read my book, MONEY WISE.) No law or regulation can prevent someone from buying something they shouldn’t own because they either do not understand it or can’t afford it. When there is a rush to leave a sports arena it is difficult not to join the exit rush.
EXAMPLE: EXECUTIVE COMPENSATION
There are many trails of unintended negative consequences created by various actions of governments. I could not list all of these, but let me start with one example and trace out some of the implications. Perhaps as a way to control compensation for executives, the IRS limited the tax deductibility of compensation expenses over $1 million dollars, unless the compensation was tied to performance. Within a year after the passage of this diktat, companies found ways to measure performance. Often these were earnings and revenues among other statistical measures. (Note that there were no restrictions on how these success ratios were to be achieved.) In some cases, executives could be richly rewarded but the investors suffered as their stock prices declined. In partial answer to these complains, the movements of stock prices were included in the reward criteria. Most often there was a comparison against a general market index as well as a narrow and hopefully more relevant subset. As CEOs were now less likely to be founder/owners, they looked to their compensations as their payoffs for doing a commendable job. Thus these professional managers now had to worry about relative stock price movements.
LOSING FOCUS ON THE LONG TERM
This change in motivation set off three impulses. First, managers manage against the time period for their assessment, which in many cases led to more short term decisions. Often these short term decisions postponed longer term benefit to the shareholder. Second, my fellow analysts were quick to sense the change in management’s focus and they also became more short term oriented. Further they understood that relative performance ranking became increasingly important. In turn, this could lead to building mathematical models in order to predict stock prices in the short term. (Later on, these and other mathematical models have led to the development of algorithms which some traders now use exclusively.) The third impulse was to view defined benefit pension plans as profit centers to hopefully produce the equivalent of earnings. At all costs, significant pension losses were to be avoided. (Again the long term investment value could be sacrificed for the benefit of this year’s financial statement.)
PORTFOLIO INSURANCE
As the concern to protect the corpus of the pension fund progressed, many institutions were attracted to “portfolio insurance,” which was an approach that in part, used futures to hedge the market. When the market went down, futures were sold, or in effect, “puts” were put on. The more the market declined, the more “insurance” was placed. Thus in the aftermath of the 500 point drop in October 1987, when the market rallied sharply, the results for some funds were disastrous. To avoid a repeat of this type of automatic trading, once the market started to drop midday on May 6th 2010, many statistical traders cancelled their automatic buy programs. This purported action may well have led to the 997 point intraday loss. (Sometimes it takes awhile for unintended actions to explode.)
A YEAR IN ONE WEEK
Last week the news was full of European debt and related problems as well as some disappointing domestic economic news. Not only was the Senate passing a stability act but there was also legislation attacking the capital gains treatment for “carried interest.”
Perhaps investors showed their fear of the unintended consequences of the week that ended on Thursday, May 13th, when we saw a “normal” year’s net asset value moves in only five trading days. There were twelve fixed income funds up 5% or more for the week and eleven down 5% or more. We saw twenty equity funds up 25% or more and ten that were down a similar amount. What is important to note that is all but one of the equity funds that gained were those with a dedicated short bias. The next best performing group was funds that held general US Treasuries, which was up about 3%. To put this calendar week in perspective, one stock, T Rowe Price (NASDAQ: TROW), perhaps the highest quality publicly traded mutual fund management company (and a personal and fund holding) ended the week at $50.99 after hitting a low of $47.32 and a high of $54.01. Another indicator of the fear in the market place is the VIX which measures the fear level surrounding the S&P 500. VIX is now about 45 compared to close 15 a few months ago.
IMPLICATIONS FOR INVESTORS
What this means to investors is that we are likely to see more swinging markets for there will be fewer swingers on the dance floor, another unintended consequence of government intervention.
What do you think?
_________________________________________
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.
We are about to watch the ultimate sausage manufacture of legislation, which continues a long line of unintended painful consequences to American investors, and much more importantly, to our economy. Soon there will be a conference committee named to resolve differences between the US Senate’s “Restoring American Financial Stability Act” and the House’s “Wall Street Reform and Consumer Protection Act.” As the various lobbyists and their dependent members of Congress write the new legislation (in which almost anything can show up), there is one almost guaranteed certainty. The ultimate result will not provide either meaningful stability or reform. This is not to say that there won’t be change. There are likely to be many changes, some large, drafted in the desire to help us avoid future problems similar to what we have suffered from over the last several years. Almost in a Newtonian fashion, the problem is that any legislative action will produce an opposite reaction by those beyond the Washington Beltway. If history is any guide, the unintended consequences will produce additional serious dislocations and risks to the soundness of investors and their retirement capital.
FEAR AND GREED
The legislation is an outgrowth of the clamoring by many “to do something” about the losses of capital, income, and most importantly, jobs. Unfortunately, changes in the rules of the game (like moving the goal posts in football), probably do not significantly alter the actions, ambitions, and the talents of the players for the most part. Throughout history, from Biblical times to the volatile trading of May 6, investors’ “animal instincts” drive people in the market place whether it is in the stock markets or the job markets. In a gross oversimplification, these are often summed up as fear and greed. (For those interested in these drivers, you may wish to read my book, MONEY WISE.) No law or regulation can prevent someone from buying something they shouldn’t own because they either do not understand it or can’t afford it. When there is a rush to leave a sports arena it is difficult not to join the exit rush.
EXAMPLE: EXECUTIVE COMPENSATION
There are many trails of unintended negative consequences created by various actions of governments. I could not list all of these, but let me start with one example and trace out some of the implications. Perhaps as a way to control compensation for executives, the IRS limited the tax deductibility of compensation expenses over $1 million dollars, unless the compensation was tied to performance. Within a year after the passage of this diktat, companies found ways to measure performance. Often these were earnings and revenues among other statistical measures. (Note that there were no restrictions on how these success ratios were to be achieved.) In some cases, executives could be richly rewarded but the investors suffered as their stock prices declined. In partial answer to these complains, the movements of stock prices were included in the reward criteria. Most often there was a comparison against a general market index as well as a narrow and hopefully more relevant subset. As CEOs were now less likely to be founder/owners, they looked to their compensations as their payoffs for doing a commendable job. Thus these professional managers now had to worry about relative stock price movements.
LOSING FOCUS ON THE LONG TERM
This change in motivation set off three impulses. First, managers manage against the time period for their assessment, which in many cases led to more short term decisions. Often these short term decisions postponed longer term benefit to the shareholder. Second, my fellow analysts were quick to sense the change in management’s focus and they also became more short term oriented. Further they understood that relative performance ranking became increasingly important. In turn, this could lead to building mathematical models in order to predict stock prices in the short term. (Later on, these and other mathematical models have led to the development of algorithms which some traders now use exclusively.) The third impulse was to view defined benefit pension plans as profit centers to hopefully produce the equivalent of earnings. At all costs, significant pension losses were to be avoided. (Again the long term investment value could be sacrificed for the benefit of this year’s financial statement.)
PORTFOLIO INSURANCE
As the concern to protect the corpus of the pension fund progressed, many institutions were attracted to “portfolio insurance,” which was an approach that in part, used futures to hedge the market. When the market went down, futures were sold, or in effect, “puts” were put on. The more the market declined, the more “insurance” was placed. Thus in the aftermath of the 500 point drop in October 1987, when the market rallied sharply, the results for some funds were disastrous. To avoid a repeat of this type of automatic trading, once the market started to drop midday on May 6th 2010, many statistical traders cancelled their automatic buy programs. This purported action may well have led to the 997 point intraday loss. (Sometimes it takes awhile for unintended actions to explode.)
A YEAR IN ONE WEEK
Last week the news was full of European debt and related problems as well as some disappointing domestic economic news. Not only was the Senate passing a stability act but there was also legislation attacking the capital gains treatment for “carried interest.”
Perhaps investors showed their fear of the unintended consequences of the week that ended on Thursday, May 13th, when we saw a “normal” year’s net asset value moves in only five trading days. There were twelve fixed income funds up 5% or more for the week and eleven down 5% or more. We saw twenty equity funds up 25% or more and ten that were down a similar amount. What is important to note that is all but one of the equity funds that gained were those with a dedicated short bias. The next best performing group was funds that held general US Treasuries, which was up about 3%. To put this calendar week in perspective, one stock, T Rowe Price (NASDAQ: TROW), perhaps the highest quality publicly traded mutual fund management company (and a personal and fund holding) ended the week at $50.99 after hitting a low of $47.32 and a high of $54.01. Another indicator of the fear in the market place is the VIX which measures the fear level surrounding the S&P 500. VIX is now about 45 compared to close 15 a few months ago.
IMPLICATIONS FOR INVESTORS
What this means to investors is that we are likely to see more swinging markets for there will be fewer swingers on the dance floor, another unintended consequence of government intervention.
What do you think?
_________________________________________
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.
Sunday, May 16, 2010
The Fork in the Road
to your Investment Policies
The fork to the left is pinpointed by real world observations, the fork to the right deals with possible negatives.
As many of the members of this blog community know, one of my critical investment laboratories is Ruth’s and my walks through The Mall at Short Hills. For those of the community who are not familiar with our annual rite, the day and the weekend after Thanksgiving each year find us at this very upscale mall looking at the size and intensity of the crowd as well as the number of labeled shopping bags they are carrying. Another clue to the robustness of the Holiday sales is how far away we have to park compared to our normal spot.
POSITIVE SIGN: HIGH-END SHOPPING
We have just returned from a visit to the mall on a very pleasant sunny Sunday. We had to go to the less convenient level to find a parking place. There were more than the normal numbers of intense shoppers, not walkers. The Apple store (NASDAQ: AAPL) in particular looked busy and the Verizon store (NYSE: VZ) appeared to have a good crowd within. In the past I have commented on the depressing number of vacant store sites. Today there are fewer vacancies and there are a number of large stores advertising their future openings and upscale merchandise. Bottom line: people were buying, merchants were expanding, and mall operators were showing signs of success in filling their sites (perhaps at discounted leases).
RESIDENTIAL REAL ESTATE
In this part of the country, dinners and cocktail parties' participants spend some time on our “local sport.” To my grandson’s dismay, this is not soccer but residential real estate. Increasingly we are hearing about bids being hit or exceeded, but with contingencies for mortgages or prior sale of the buyers’ current homes. Months ago there were little or no such conversations.
INVESTMENT IMPLICATIONS
The investment implications of this left fork are that the economy is in a state of uneven recovery and some hope has returned. From a portfolio standpoint, investment in depressed consumer discretionary items as well as some ties to home improvements appears to make sense. These moves are based on the return some form of normality, even if it’s the “new normal” of lower returns.
SOBERING SIGNS FROM EUROPE
The right fork is more difficult to elucidate. Last week one of the questions that my blog dealt with was, "Why didn’t a number of investors jump in at what appeared to be bargain prices?" As mentioned, sharp market movements in retrospect often are found to be inflection points, marking changes of direction in investment thinking. The immediate concern in the first week of May was the clumsy way the European Community was dealing with the Greek problems. The bounce-back sustained in this past week focused on multi-tiered funding approaches by the EC and the IMF. There were some austerity measures announced for Greece, Portugal, Spain and Ireland. I suspect that these will not be sufficient in the long run. At this point a much bigger potential funding deficit in Italy is not being publicly addressed. A number of commentators have compared the deficit tracks of Greece and the US, which is sobering. What has one concerned is the pattern of governments to socialize, if not nationalize, what in the past has been private responsibilities. As families became clans, then tribes and morphed into nations, the primary need assigned to government was defense from without.
GOVERNMENT SERVICES OR PRIVATE JOBS?
To pay for services by government, taxes were introduced which led to government sponsored coinage and building roads. Over time, provisions for education and retirement became government obligation in some societies. In Europe and now in the US, the provision of health care is being socialized. What is not written in our, or other countries’ constitutions, is the creation and preservation of jobs.
Almost inevitably when a service that has been or could be provided by the private sector is turned over to the government, inefficiency and corruption occur at some levels. These are additional transfers from the private sector to the public sector, not dissimilar to declared taxes. There are differences caused by these inefficiencies and corruptions which build rigidities into the economic systems. Over time these elements act as an additional tax on the provision of these services to the community. Countries, states and cities with higher net effective tax will inevitably lose economic opportunities and therefore jobs to more efficient locations.
MANAGING EXPECTATIONS
Are the problems of just about every country which borders the Mediterranean akin to a flock of canaries in the mine? Did some investors perceive the problem without seeing any significant attempt to structurally reform our own economy? If that is their growing perception, they should start to discount more heavily what they expect to be normalized or peak recovery earnings. In other words, do stocks in the future, not have the same potential capital appreciation that they delivered to us in the past century? (Not counting the last ten years of little to no real growth.)
MY OUTLOOK
For those that are looking down the right fork, they should consider using significant recovery rallies, including new highs, as selling opportunities. As long term bonds are already unattractive in terms of income and inflation, they are unlikely to be a long term attractive alternative for equity money freed from the domestic market. What is worthwhile, starting today, is the search for governments that are being more responsible to their citizens and investors. Those that are doing so today are more likely to continue to do so rather than the countries that recover from too much government spending.
The choice of which fork is up to you and for awhile one could attempt to do both, but that will require an alert investment manager. Keep us informed.
_________________________________________
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.
As many of the members of this blog community know, one of my critical investment laboratories is Ruth’s and my walks through The Mall at Short Hills. For those of the community who are not familiar with our annual rite, the day and the weekend after Thanksgiving each year find us at this very upscale mall looking at the size and intensity of the crowd as well as the number of labeled shopping bags they are carrying. Another clue to the robustness of the Holiday sales is how far away we have to park compared to our normal spot.
POSITIVE SIGN: HIGH-END SHOPPING
We have just returned from a visit to the mall on a very pleasant sunny Sunday. We had to go to the less convenient level to find a parking place. There were more than the normal numbers of intense shoppers, not walkers. The Apple store (NASDAQ: AAPL) in particular looked busy and the Verizon store (NYSE: VZ) appeared to have a good crowd within. In the past I have commented on the depressing number of vacant store sites. Today there are fewer vacancies and there are a number of large stores advertising their future openings and upscale merchandise. Bottom line: people were buying, merchants were expanding, and mall operators were showing signs of success in filling their sites (perhaps at discounted leases).
RESIDENTIAL REAL ESTATE
In this part of the country, dinners and cocktail parties' participants spend some time on our “local sport.” To my grandson’s dismay, this is not soccer but residential real estate. Increasingly we are hearing about bids being hit or exceeded, but with contingencies for mortgages or prior sale of the buyers’ current homes. Months ago there were little or no such conversations.
INVESTMENT IMPLICATIONS
The investment implications of this left fork are that the economy is in a state of uneven recovery and some hope has returned. From a portfolio standpoint, investment in depressed consumer discretionary items as well as some ties to home improvements appears to make sense. These moves are based on the return some form of normality, even if it’s the “new normal” of lower returns.
SOBERING SIGNS FROM EUROPE
The right fork is more difficult to elucidate. Last week one of the questions that my blog dealt with was, "Why didn’t a number of investors jump in at what appeared to be bargain prices?" As mentioned, sharp market movements in retrospect often are found to be inflection points, marking changes of direction in investment thinking. The immediate concern in the first week of May was the clumsy way the European Community was dealing with the Greek problems. The bounce-back sustained in this past week focused on multi-tiered funding approaches by the EC and the IMF. There were some austerity measures announced for Greece, Portugal, Spain and Ireland. I suspect that these will not be sufficient in the long run. At this point a much bigger potential funding deficit in Italy is not being publicly addressed. A number of commentators have compared the deficit tracks of Greece and the US, which is sobering. What has one concerned is the pattern of governments to socialize, if not nationalize, what in the past has been private responsibilities. As families became clans, then tribes and morphed into nations, the primary need assigned to government was defense from without.
GOVERNMENT SERVICES OR PRIVATE JOBS?
To pay for services by government, taxes were introduced which led to government sponsored coinage and building roads. Over time, provisions for education and retirement became government obligation in some societies. In Europe and now in the US, the provision of health care is being socialized. What is not written in our, or other countries’ constitutions, is the creation and preservation of jobs.
Almost inevitably when a service that has been or could be provided by the private sector is turned over to the government, inefficiency and corruption occur at some levels. These are additional transfers from the private sector to the public sector, not dissimilar to declared taxes. There are differences caused by these inefficiencies and corruptions which build rigidities into the economic systems. Over time these elements act as an additional tax on the provision of these services to the community. Countries, states and cities with higher net effective tax will inevitably lose economic opportunities and therefore jobs to more efficient locations.
MANAGING EXPECTATIONS
Are the problems of just about every country which borders the Mediterranean akin to a flock of canaries in the mine? Did some investors perceive the problem without seeing any significant attempt to structurally reform our own economy? If that is their growing perception, they should start to discount more heavily what they expect to be normalized or peak recovery earnings. In other words, do stocks in the future, not have the same potential capital appreciation that they delivered to us in the past century? (Not counting the last ten years of little to no real growth.)
MY OUTLOOK
For those that are looking down the right fork, they should consider using significant recovery rallies, including new highs, as selling opportunities. As long term bonds are already unattractive in terms of income and inflation, they are unlikely to be a long term attractive alternative for equity money freed from the domestic market. What is worthwhile, starting today, is the search for governments that are being more responsible to their citizens and investors. Those that are doing so today are more likely to continue to do so rather than the countries that recover from too much government spending.
The choice of which fork is up to you and for awhile one could attempt to do both, but that will require an alert investment manager. Keep us informed.
_________________________________________
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.
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