Shorter-Term Worries, Longer-Term Opportunities

Introduction

We are not enjoying complacency about securities' prices, we are suffering from petrification. One of the supposed benefits of holidays be they secular such as Labor Day, bank holidays or religious fast days, is it gives investors and those who are dependent upon investors a chance for introspection.

On the surface we are experiencing relative calm with the month of August posting the second lowest volatility in a decade of S &P 500 performance. I have yet to meet any professional or individual investor who is happy with the markets - stock, bond, or commodity. The relative lack of movement is anything but creating complacency but rather a deep seated fear of being wrongly positioned for the next market. Until magically they see further into the future than they are now, investors are petrified to act.

Short-Term Worries

Several new books and other long treatises can drone on as to all of the problems facing our global societies, economies, political leadership and securities markets. I am going to list a number of concerns that occurred to me over this three day weekend and it is not an exhaustive list:

1.  Over-valuation of leading components of popular securities indices due to flows into passive portfolios, including ETFs. These buyers are participators not evaluators.

2.  A record level of long contracts on the Dow Jones Industrial Average. (This level of speculation is normally wrong. However, in today's world I wonder how many of these contracts are paired with shorts on individual stocks.)

3.  Moody's^* warns "take cover if defaults climb through 2017."

4.  John Authers of the FT in suggesting rules for investing success, recommends the need to be humble as the markets are not perfectly efficient and the greater the price paid for a security the lower the potential return.

5.  In a recasting of the famous economist's view of a “Minsky  Moment,” the illusion of control encourages risk-taking behavior. Much of what is being pitched these days is expressed as low risk due to the fact that they are government actions and in the past history few things have gone bad.

*Held in the private fund I manage.

In the latest Marathon Asset Management Global Investment Review, the London-based firm tells the story of a famed Soviet professor of statistics who regularly did not take shelter during the Moscow air raids in World War II. When asked, he pointed out that there were seven million people living in the city and one elephant living in the Moscow Zoo. Thus he felt comfortable not going into the shelters until one night he showed up at a shelter. He then announced that the prior night they killed the lone elephant. The message: Change when the facts change.

Longer-Term Opportunities

This weekend I sat next to another guest at a wedding; she had worked in development at Yale before it was famed for extraordinary investment performance, but during the period that it was building that record. We chatted about the Chief Investment Officer who had introduced alternatives to stock and bond portfolios. We concluded that one of the reasons for Yale's success during that time was that few or any of its major academic competitors were taking advantages of these opportunities.

During the current period of complacency/petrification I see a similar opportunity. Too many very bright investors are focusing on the current (apparently insurmountable) problems and not at the opportunities that always exist but too often are hidden to us because of our perception deficits.

Keith Ambachtsteer contributed an article to the FT entitled "Long-term thinking will lead the way to improved returns." He knows by experience in affecting a number of Canadian and to a lesser degree, US pension funds. His focus is to keep the attention on the long-term and not get bogged down in the short-term.

If one does focus on the longer-term, an investor has two mathematical advantages working in his/her favor. The first is the compounding impact of reinvesting income. Over the last five years the reinvestment of distributions from the stocks in the Dow Jones Industrial Average raised the DJIA total return by 33.85% over its simple price change gain. The second mathematical power going for investors in the long run is that almost all of our lives we have been in a period of secular growth with both demographics and technology helping to enlarge the demand for what we produce.

During a period when the negatives are being accentuated, too few people are searching for positive opportunities. In the US and some other countries, we will have both new political leaders as well, I believe, quite different legislative bodies. Perhaps we will also have some movement in the judiciaries. As much as many would like, they are not going to be able to slavishly copy what was done in the past. Even slight changes will create opportunities for those who are looking for them. Major changes can create major opportunities. I believe we will see many. 

While it may be too early to tell, one should look for ways to foresee changes in both the labor and consumer markets. As an example, keying off this weekend's news of the poor showing of Germany’s ruling party in Angela Merkel’s own district due to the rise of an anti-immigrant party that has potential implications in Germany, the rest of Europe and possibly the US.

How to Play

During these uncertain times I believe our preferred structure of sub portfolios addressed to specific time spans can be of particular value. Regular readers may be familiar with my TIMESPAN L Portfolios^®.  I would suggest that the need to meet payment requirements over the next couple of years will require close, very short-term management that is extremely sensitive to changes of credit conditions and shifting short-term interest rates. (The first, or Operational Portfolio.)

The replenishment requirements of the expended operational funds (the second or Replenishment Portfolio) probably need to deal with at least one down market year before the new government leaders leave office. On the other hand, investing for endowment (the third portfolio in the series) and other intermediate and long-term money have a great opportunity to invest wisely in less popular investments. For the truly long-term investor there will be ample opportunities to invest in both new and established disrupters.

Question of the week: Please help me find disrupters, what are your current favorites? 

_________________

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

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2016

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

UPDATE: Lessons Remain, Icahn Facts Change

Update: Lessons Remain, Icahn Facts Change

According to Carl Icahn he did not give an order to sell some Herbalife stock to Jefferies, his broker. (Jefferies is the largest operating investment in Leucadia a stock that is owned in our investment accounts.) This is in spite of a Wall Street Journal story on Friday that the firm had been having discussions for about a month with potential buyers.

A Probable Scenario

What may have happened, with or without his permission: Jefferies was trying to assess the potential price impact if Mr. Icahn wished to sell his position. This is a somewhat normal approach for an institutional broker potentially dealing with a very large block of stock with somewhat limited liquidity.

Regardless of the specific facts, apparently those active in the stock believed that Mr. Icahn was a near-term potential seller. Some may have sold on this belief. Potential buyers may have backed off. For whatever the reason, the price of Herbalife stock declined and Mr. Icahn bought more stock.

Our purpose in highlighting the potential sale and actual buying of the stock was to demonstrate that it is not unusual for a successful investor to have a price which they would be a buyer and another price when they would be a seller.

The lesson remains a valid observation even though apparently in this case the facts are not what we believed them to be. 

Five Year Compound Annual Growth Rate

Early versions of my blog post below omitted that the Five year performance data was based on a compounded annual growth rate.

For those who missed my original blog post, please see below.

Positive Inputs Favor Long-Term Equity Investing

Introduction

The very positive attributes attached to an activity frequently also carries some additional negative attributes. Often the investment marketing armies sing the praises of individual stocks and equity mutual funds due to their near-instant liquidity. In the US, one can get out of the market 252 trading days a year. What the proponents don't mention is the temptation to react to news and/or change in sentiments and over-trade a long-term investment account. While there are some managers that have great trading skills, the few that have these skills can make more money for themselves and possibly their investors in hedge funds. Generally I find that the most successful managers of long-term oriented equity funds have a portfolio turnover rate that is less than the average. As bad or unexpected things do happen to companies and markets, some occasional pruning is often necessary otherwise they will mirror passive portfolios or ETFs which can be a painful experience in a major market decline.

Each day if not each hour, a holder of equity securities is bombarded with new information, including some of which is accurate. The job of a wise, experienced manager is to identify what incremental bit of information is of such potential magnitude that it should cause a portfolio change. The risks of premature or basically wrong decisions are not just what it does to the investment account. The biggest penalty is a human failing to quickly recognize a mistake and buy back the investment just sold or in some cases buy more. This past week it was widely reported that Carl Icahn was interested in selling some or all of his large position in a particular stock. The rumor drove the stock lower, so much lower that Mr. Icahn bought more rather than selling. While some may feel that his actions were manipulating the market, I believe he demonstrated one of the attributes that has made him successful. He has identified both a sales price and a buy price and will move appropriately whatever the market serves up. Most managers do not act as dynamically and I am not sure that I want to see much of this type of activity in mutual funds that we invest.

The Current Situation

Perhaps it is just the summer doldrums or waiting for the Fed to raise short-term interest rates, or until various political decisions become clear. Regardless, there are very narrow price changes. Thus significantly below-average volatility is being experienced. Some may call it complacency. I think it is more petrified. Petrified of zigging when we should be zagging.

To me there are more positive elements present than negative, but I recognize that the lack of stabilizing capital can lead to significant declines. This last week through Thursday, (prior to the somewhat inconclusive Jackson Hole speech by the Chairman of the Federal Reserve) could show the tendency to accentuate the negative.

The best sample of inputs that I look at is the performance of mutual funds broken into various investment objective categories. My old firm, Lipper Inc, now a part of ThomsonReuters, publishes the weekly performance of 96 separate mutual fund peer groups. In the week through August 25th, there was only one investment objective that gained more than 1%, the Dedicated Short Biased funds +1.40%. On the other hand there were 16 separate categories showing declines of over 1%. This list was led by the Precious Metals investment objective ­­-10.29%, followed by 4 different commodities categories off by 2 and 3%, 3 energy related peer groups, 2 Health/Biotech fund types, and 2 Latin American and Emerging Market Equity funds. The breadth of the list of declines demonstrates the unforgiving  nature of the market that seems like a neighborhood of one-way streets.

In the short-run, the positive offset to a somewhat punishing market decline is a signal that the bond market is flashing for stocks. Barron's Best bond yields dropped to 2.86% from 2.93% in the prior week and 3.81% a year ago. Barron's has found that as yields rise and therefore bond prices decline, that within the foreseeable future stock prices will rise.

The Longer Term Picture

My primary responsibility is to invest for institutions and a few families for the long-term. The shortest judgment period for account owners is in the Replenishment Portfolio of our TIMESPAN L Portfolios^® which is normally five years.

I assume over most five year periods there will be at least one year with a decline of about 20%.  I am reasonably confident currently that we can meet the obligations to replenish the expended operational funding, normally about two years’ payments. My confidence is based on the very same fund data source that was used above to focus on last week's performance. In the Lipper, Inc. report, the compound annual growth rate for US Diversified Equity Funds for the last five years was +8.79%. In some cases it could be wise to leaven the cake for stability or to address specific opportunities by dipping into the following categories: BBB bonds 5.39%, High Yield bonds +5.35%, Mixed Asset funds +5.35%, Sector funds +4.45% and World Equity funds +2.54%. Using funds out of the last two categories could be worthwhile at times particularly for longer term timespans in terms of the World Equity funds and shorter timespans for the Sector funds. Currently I am noticing Small Cap funds’ performance is accelerating both in the US and Europe.

Others, including Charles Schwab & Co. believe that the market has further to run. I concur primarily because in the equity world I don't see massive speculation, yet. However, I am concerned by both the level of leveraged speculation in various government bond markets led by the US, and by the growth of non-bank credit sources. 

 

On a secular basis one can see a number of possible trends that will be coming over the horizon that can be bullish for the equity investor wishing to meet future desired funding needs. Not all of these will work out and each is not without controversy, but each has the germs of a great force:

1.  Instead of the politicians focusing on employment votes, they could shift to the larger consumer vote found in Walmart and other places. This can lead to a much reduced level of tariffs and non-tariff trade barriers. The key to this happening is to find suitable employment for the low-skilled which could be in extended healthcare and infrastructure needs.

2.  An aging population leading to less malls and more delivery services.

3.  Less reliance on government and central banks as decision-makers and more reliance on market forces with profit-oriented multinationals leading.

4.  New leadership in government, business, and non-profit sectors that are better equipped to manage than the current seat-warmers.

5.  Corporations reducing or perhaps eliminating regular repurchase programs being replaced with longer term payoff capital expenditures.

6.  The global recognition of the need to reduce government in Europe, Asia and North America.

In Conclusion

I would not wait for the eventual dips to get to the proper balancing of your accounts.  At this point, for long-term accounts, the penalty of missing today’s price opportunities will seem small when viewed from the completion of your long-term funding desires.

Publishing Note

Due to the Labor Day holiday in the US, next week’s blog will be published Monday evening, September 5.

_________________

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

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2016

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.

Positive Inputs Favor Long-Term Equity Investing

Introduction

The very positive attributes attached to an activity frequently also carries some additional negative attributes. Often the investment marketing armies sing the praises of individual stocks and equity mutual funds due to their near-instant liquidity. In the US, one can get out of the market 252 trading days a year. What the proponents don't mention is the temptation to react to news and/or change in sentiments and over-trade a long-term investment account. While there are some managers that have great trading skills, the few that have these skills can make more money for themselves and possibly their investors in hedge funds. Generally I find that the most successful managers of long-term oriented equity funds have a portfolio turnover rate that is less than the average. As bad or unexpected things do happen to companies and markets, some occasional pruning is often necessary otherwise they will mirror passive portfolios or ETFs which can be a painful experience in a major market decline.

Each day if not each hour, a holder of equity securities is bombarded with new information, including some of which is accurate. The job of a wise, experienced manager is to identify what incremental bit of information is of such potential magnitude that it should cause a portfolio change. The risks of premature or basically wrong decisions are not just what it does to the investment account. The biggest penalty is a human failing to quickly recognize a mistake and buy back the investment just sold or in some cases buy more. This past week it was widely reported that Carl Icahn was interested in selling some or all of his large position in a particular stock. The rumor drove the stock lower, so much lower that Mr. Icahn bought more rather than selling. While some may feel that his actions were manipulating the market, I believe he demonstrated one of the attributes that has made him successful. He has identified both a sales price and a buy price and will move appropriately whatever the market serves up. Most managers do not act as dynamically and I am not sure that I want to see much of this type of activity in mutual funds that we invest.

The Current Situation

Perhaps it is just the summer doldrums or waiting for the Fed to raise short-term interest rates, or until various political decisions become clear. Regardless, there are very narrow price changes. Thus significantly below-average volatility is being experienced. Some may call it complacency. I think it is more petrified. Petrified of zigging when we should be zagging.

To me there are more positive elements present than negative, but I recognize that the lack of stabilizing capital can lead to significant declines. This last week through Thursday, (prior to the somewhat inconclusive Jackson Hole speech by the Chairman of the Federal Reserve) could show the tendency to accentuate the negative.

The best sample of inputs that I look at is the performance of mutual funds broken into various investment objective categories. My old firm, Lipper Inc, now a part of ThomsonReuters, publishes the weekly performance of 96 separate mutual fund peer groups. In the week through August 25th, there was only one investment objective that gained more than 1%, the Dedicated Short Biased funds +1.40%. On the other hand there were 16 separate categories showing declines of over 1%. This list was led by the Precious Metals investment objective ­­-10.29%, followed by 4 different commodities categories off by 2 and 3%, 3 energy related peer groups, 2 Health/Biotech fund types, and 2 Latin American and Emerging Market Equity funds. The breadth of the list of declines demonstrates the unforgiving  nature of the market that seems like a neighborhood of one-way streets.

In the short-run, the positive offset to a somewhat punishing market decline is a signal that the bond market is flashing for stocks. Barron's Best bond yields dropped to 2.86% from 2.93% in the prior week and 3.81% a year ago. Barron's has found that as yields rise and therefore bond prices decline, that within the foreseeable future stock prices will rise.

The Longer Term Picture

My primary responsibility is to invest for institutions and a few families for the long-term. The shortest judgment period for account owners is in the Replenishment Portfolio of our TIMESPAN L Portfolios^® which is normally five years. 

I assume over most five year periods there will be at least one year with a decline of about 20%.  I am reasonably confident currently that we can meet the obligations to replenish the expended operational funding, normally about two years’ payments. My confidence is based on the very same fund data source that was used above to focus on last week's performance. In the Lipper, Inc. report, the average gain for US Diversified Equity Funds for the last five years was +8.79%. In some cases it could be wise to leaven the cake for stability or to address specific opportunities by dipping into the following categories: BBB bonds 5.39%, High Yield bonds +5.35%, Mixed Asset funds +5.35%, Sector funds +4.45% and World Equity funds +2.54%. Using funds out of the last two categories could be worthwhile at times particularly for longer term timespans in terms of the World Equity funds and shorter timespans for the Sector funds. Currently I am noticing Small Cap funds’ performance is accelerating both in the US and Europe.

Others, including Charles Schwab & Co. believe that the market has further to run. I concur primarily because in the equity world I don't see massive speculation, yet. However, I am concerned by both the level of leveraged speculation in various government bond markets led by the US, and by the growth of non-bank credit sources. 

 

On a secular basis one can see a number of possible trends that will be coming over the horizon that can be bullish for the equity investor wishing to meet future desired funding needs. Not all of these will work out and each is not without controversy, but each has the germs of a great force:

1.  Instead of the politicians focusing on employment votes, they could shift to the larger consumer vote found in Walmart and other places. This can lead to a much reduced level of tariffs and non-tariff trade barriers. The key to this happening is to find suitable employment for the low-skilled which could be in extended healthcare and infrastructure needs.

2.  An aging population leading to less malls and more delivery services.

3.  Less reliance on government and central banks as decision-makers and more reliance on market forces with profit-oriented multinationals leading.

4.  New leadership in government, business, and non-profit sectors that are better equipped to manage than the current seat-warmers.

5.  Corporations reducing or perhaps eliminating regular repurchase programs being replaced with longer term payoff capital expenditures.

6.  The global recognition of the need to reduce government in Europe, Asia and North America.

In Conclusion

I would not wait for the eventual dips to get to the proper balancing of your accounts.  At this point, for long-term accounts, the penalty of missing today’s price opportunities will seem small when viewed from the completion of your long-term funding desires.

Publishing Note

Due to the Labor Day holiday in the US, next week’s blog will be published Monday evening, September 5.

_________________

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

Did someone forward you this Blog?  To receive Mike Lipper’s Blog each Monday, please subscribe using the email or RSS feed buttons in the left column of MikeLipper.Blogspot.com 

Copyright © 2008 - 2016

A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.