VALUE INVESTING WILL BE SUPERIOR BUT IT MAY HAPPEN AFTER THE RECESSION - Weekly Blog # 574

Mike Lipper’s Monday Morning Musings

VALUE INVESTING WILL BE SUPERIOR

BUT IT MAY HAPPEN AFTER THE RECESSION

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

Current Inputs
A few weeks ago, one of our perceptive readers asked what advice I had for his good friends that were managers of value stock portfolios. My unexplained response may have seemed nonsensical in the face of relatively poor performance compared to market. I should have explained my thinking. My reply was focused on the business of providing investment advice. I saw a short-term continuation of poor relative performance leading to less money going into these portfolios and a significant number of the managers withdrawing from the business. Lower prices often result from fewer value buyers participating in the market. Without new performance seeking money in the markets the remaining portfolio managers will need to liquidate some or eventually all their holdings. Typically, they will sell their most liquid holdings first and be forced to sell their less-liquid positions when that is all they have left. These sales will be at bargain prices for those that have the cash to take advantage, but there will be few with the cash, courage, and foresight to take advantage of these great bargains. These insightful managers will have less competition and thus they can earn premium level fees.

Recently I reviewed the performance of a large Planned-Giving Fund run by a well-known and respected manager with a recognized value bias. In looking over their performance record, it was superior for ten years, but not for shorter time periods. Just this week we were informed that a” deep-value” manager was closing his shop, as he was no longer able to produce the good returns he had generated in the past.

These inputs led me to explore the structural reason why this group of intelligent, formerly good performers, were not doing better in a market that was performing extremely well. Like many analysts who are closet history students, my search for an explanation focused on recent US financial history and recorded history from Biblical and Ancient societies.

Last Ten Years
 Because government promoted home ownership, various government subsidies and tax credits led to excessive ownership of homes by those stretched in their ability to support mortgages and the reasonable upkeep on home purchases. In some cases the buyers lied on their applications, but much more significantly lied to themselves and their families as to the predictability of their income and wealth.

In the aftermath of the mortgage crisis the government focused on the mis-selling and mis-labeling of tranches and ended up penalizing the financial industry with burdensome regulation and capital requirements. Further, Central Banks pumped money into the market in what came to be known as “quantitative easing”. This has led to a ten-year period where interest rates have been kept artificially low, depriving savers of the rates that paid them not to spend, leading to a global shortage of savings. More importantly, low rates and the availability of capital has led both commercial banks and non-bank financials to make commercial loans at interest rates which encouraged undisciplined credit extensions. Much of this money went to marginal firms for capacity expansions. This has hurt the value investor, as demonstrated by their poor investment performance compared to other investors.

Companies that value investors favor have the following characteristics:

• Strong balance sheets (under-utilized borrowing power)
• Physical assets where the current market value is larger than the depreciated book value
• Close to impregnable market penetration of good customers
• Unique and highly prized intellectual property
• Respected in-depth management
• Stable shareholder base

It takes many years if not generations to build these. The field of competition changes when marginal companies with a poor financial record and large debt can acquire even more debt at low cost. Often, when marginal companies build excess capacity they fight for market share. They do this by lowering prices, which in turn devalues the more sound companies. With a more leveraged balance sheet the marginal company can report faster earnings growth than the value focused company, at least for a while. Thus, in a period where growth is most valued, the marginals will be the more productive investments, until the next recession.

Ancient History + Human Nature
The Bible and archaeology have recorded various agricultural cycles, often tied to weather but also the expansion of crop or grazing land. Humans are driven by fear and greed. When they are in rough balance, humans tend to be both disciplined and careful. However, when either side is predominant humans tend to do extreme things and concentrate all their resources to gain more wealth/power or horde them to avoid current or future crises. When a mass of people do the same thing, like all going to one side of a boat, they can capsize the boat. That is why we have always needed recessions to correct the excesses of a prior period. I see nothing that has repealed this need and thus I expect we will have a recession at some point.

Where are We Today?
While I can’t give a date for the top of the market prior to the beginning of the next recession, nor the percent of the market gain, I can make the following observations:

1. Currently, the US stock market is being led by the NASDAQ composite, made up mostly of tech and services providers. However, this past week the stocks listed on the New York Sock Exchange had a higher percentage of gainers 77%vs. 69%. Perhaps the valuation gaps are too great - NYSE p/e 18.47x vs NASDAQ p/e 23.67x. If the rate of gain slows, perhaps yields will be more important - NYSE 2.16% vs. NASDAQ 0.99%.
2. Despite the strength of the equity market NYSE volume is flat compared to a year ago. The absence of speculative enthusiasm for listed stocks suggests there is more upside ahead.
3. While it is broadly proclaimed that the Federal Reserve won’t raise interest rates this year, this week the average interest rate offered by savings institutions rose 5 basis points to 0.65 bps. I interpret this as savings banks encouraging more deposits for them to loan out. This may support the surprise 3.1% first quarter GDP announcement. I have always believed that the Fed is a follower and not a leader on setting interest rates.
4. Each week the WSJ tracks the prices of 72 securities, currencies, and commodities. Until this week, gainers outnumbered the losers, this week they are exactly even.
5. The bond market is often more attuned to changing financial conditions. In the latest week yields on high quality bonds rose 14 bps, while the yield on intermediate credits declined 4 bps. [Prices move inversely to yields.] This suggests that bond investors are concerned about the future value of the highest quality bonds.

What to Do with Value Funds/ Managers
As a portfolio manager of portfolios of mutual funds, we invest globally in both growth and value focused funds. I expect the more growth-oriented funds to provide both more appreciation and volatility. The value-focused funds will probably go down less in poor markets. However, when interest rates go up, as I expect them to do before the next presidential inaugural, the value merchandise should do better and will receive a reasonable amount of M&A activity.

What Do You Think?  


Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/04/contrarian-observations-not-predictions.html

https://mikelipper.blogspot.com/2019/04/not-yet-peak-luck-lessons-weekly-blog.html

https://mikelipper.blogspot.com/2019/04/investing-in-quality-for-growth-or.html



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Contrarian Observations, Not Predictions, But Concerns - Weekly Blog # 573

Mike Lipper’s Monday Morning Musings

Contrarian Observations, Not Predictions, But Concerns

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

Contrarians look at the world differently, searching for misleading, generally accepted view-points. My purpose is to not to be contrary, but to look for opportunities to reduce risk and make an unexpected profit. While one of the maximums of trading is that “the trend is your friend”, the contrarian believes that all trends eventually end. After the trend ends there is a shift in direction, often a dramatic one. This week’s blog looks at several current observations that could be sign-posts for a change in direction. The prudent investor should consider these to be possible early warnings signs.

Long-Term Observations
Through the 18th of April the average US Diversified Equity fund gained +15.86%. This rise is significantly higher than the 2019 earnings per share projection for the underlying stocks in the portfolios. If there were no further performance gains by the end of the year, the performance comparison versus the historic gains of the S&P 500 since 1926 raises some questions. Of the 92 completed years, only 42 or 45.6% were better than the 4 ½ months of this year. An actuary would question further progress in 2019.

In reading “The Unlikely Reformer”, a book by my friend Matt Fink. In the book he discusses the history of Carter Glass (Glass-Steagall, Federal Reserve Act, Securities & Exchange Act of 1934). The book makes much of his deep concern for the amount of bank issued credit used for speculation by Wall Street. Today there are some that are similarly concerned, but not about the retail credit used in buying stocks. The concern is about the build-up of corporate credit, which has been issued under very liberal terms for acquisitions and buy-backs of common shares. One of the multiple causes of the Great Depression was the explosion of credit. Some see a similar pattern regarding the explosion of credit issued largely outside of the banking system. 

Intermediate-Term Concerns
Two mouthpieces are telling us not to worry about inflation.

• Robert Kaplan, the president of the Dallas Federal Reserve Bank, ex Goldman Sachs partner and Harvard Business School Professor stated, “No Threat of Inflation”. 

• Bloomberg Business Week’s cover asks, “Is Inflation Dead?”. 

There is an old Biblical Expression “Man plans, and God Laughs”. One of the things I learned from the racetrack is that occasionally a long-shot wins. Surprises are normal in the history of economics, business, politics, and markets. Though the rate of inflation has been low for many years, I suspect it may not continue.

There has been wide dispersion in the performance of equity mutual funds for the five years ended April 18th. The average S&P 500 index fund gained +11.31% annualized, while the average Financial Services Fund gained +8.37% and the average International fund gained +3.33%. Looking to the future, the odds of a similar performance spread and rates of gain are at best questionable.

Shorter-Term Questions 
The three stock price composite indices around the world currently performing best are Shenzhen +38.8%, Shanghai +30.5%, and NASDAQ +20.6%. All three indices are fueled in part by a combination of technological products and services, easier credit, and IPOs. Are these gains sustainable?

A partial answer to the question above is reflected in the two largest ETF short positions as a percent of the shares outstanding: iShares China Large Cap 17.3% and SPDR Bloomberg Barclays High Yield Bond 17%. I don’t know whether the bulk of these holdings are for hedging purposes or directional bets in a speculative Market.


Question of the Week:
Did anything happen last week that is causing you to change your investment positions or attitudes? 




Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/04/not-yet-peak-luck-lessons-weekly-blog.html

https://mikelipper.blogspot.com/2019/04/investing-in-quality-for-growth-or.html

https://mikelipper.blogspot.com/2019/03/investment-committee-and-investors-be.html



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A. Michael Lipper, CFA

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Not Yet a Peak & Luck Lessons - Weekly Blog # 572

Mike Lipper’s Monday Morning Musings

Not Yet a Peak & Luck Lessons

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

       

Absolute price tops and bottoms rarely occur. Most of the time market prices fluctuate without creating important turning points. Comments about investment markets are mainly focused on earnings and related valuations and these have not recently been helpful as guides to making investment decisions. In their place some are relying on various statistical measures of investors’ sentiments and the current somewhat bullish indicators are not generating a lot of enthusiasm. There is something absent from the picture. The stock market has been moving up for three and half months, but the volume on the New York Stock Exchange in 2019 is down -4.68%. An even better measure of short-term speculation, the NASDAQ composite, is up + 1.31%. Some short-term traders may be concerned that in March the three major stock indices had a gap in their price charts. Many market analysts believe that gaps need to be filled before a price trend can be relied upon. While no forecasting measure is ever 100% accurate all the time, I believe we have not yet reached a peak level.

Sports World Experience

One should pay attention to the importance of luck, especially in light of Tiger Woods winning “The Masters” golf championship this weekend. A remarkable comeback for him considering his physical and personal problems. Not taking anything away from the winner, but a couple of golfers that were ahead of him ran into some poor luck with a few of their strokes. In my basic investment analysis course at the racetrack I would call this “racing luck”. To me the most useful analytical time at the track is the twenty to thirty-minute period between races. This is the time during which I compare the results of the prior race against those predicted by my handicapping analysis. Most often, with the benefit of hindsight, one can find in the records of past races the reason the results turned out as they did. In the minority of instances, when the results could not have been predicted, it was the result of the record being incomplete or the result of unanticipated “racing luck”.

My Lucky Experiences

I have had two experiences that had nothing to do with my securities analysis training and certainly was not tested in my CFA exams. I would call these examples of racing luck.  

• As a result of following closed-end funds I owned a few shares of an Eaton Vance fund who had a relationship with Winrock, the venture capital arm of the Rockefellers. They had a share interest in some of their holdings and for regulatory reasons needed to terminate it, resulting in the closed-end fund distributing ownership of those shares to its shareholders. Consequently, I own a few shares of Apple at under $1 apiece. (At some point in the distant past I sold half the position because I had enough losses in other securities to offset the large gain in Apple. VERY DUMB MOVE to let taxes dictate an investment decision, an important lesson.)

• Many years ago I took out a life insurance policy and later realized that unless I passed prematurely it was a bad use of money. The rate of return the insurance company needed to meet its obligation was low relative to what it was earning on its investments. Thus, I bought some shares in the insurance company to take advantage of the spread and the float in the investment account. As a result, I would have a sales force working for me to find others that did not fully understand the economics of insurance. This is a lessoned not taught at Columbia. Over the years the insurance company did well but was never a high-flying stock. Recently it was bought out for cash and stock, the cash being many multiplies of my cost. Thus, I am more than satisfied. The stock is CVS Health, which I currently hold. I don’t generally directly invest in the health care industry, but let my choice of specialty and diversified mutual funds give me exposure. Barron’s recently had a cover story titled “CVS This could be the future of healthcare. Time to Buy”.  According to the article it is selling at an 8 P/E and a yield of 3.79%, which is in the range of the insurance stock I bought years ago.

Lessons

1. As indicated, don’t let taxes alone drive investment decisions. Sell when there is a better use for the money.
2. One needs to be invested to allow good luck to happen to one’s money. If I had to buy them independently, I probably would not have owned these winners.
3. Over long periods of time, investing in a portfolio of equities works better than trying to time the market
4. Cash reserves are appropriate to meet expected payments and for use as a possible opportunity reserve.

Questions of the Week:

1. What is the range of your opportunity reserve?
2. How long should you keep the reserve if you can’t find a commitment?

  

Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2019/04/investing-in-quality-for-growth-or.html

https://mikelipper.blogspot.com/2019/03/investment-committee-and-investors-be.html

https://mikelipper.blogspot.com/2019/03/the-actively-worrying-classpassively.html

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A. Michael Lipper, CFA

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Investing in Quality for Growth or Value - Weekly Blog # 571

                               

Mike Lipper’s Monday Morning Musings

Investing in Quality for Growth or Value

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

     
                               

Capital Preservation vs. Capital Preservation
Occasionally I assign Capital Appreciation or Capital Preservation labels to each security in my portfolio. These identities may change with each time period examined. The purpose of this exercise is to examine my decision process during the expected top and bottom phases of a cyclical market. (Perhaps a +/- 10% move before or after a recognized turning point has been reached.) For me, this is not an easy exercise and needs to be repeated periodically.

What makes this process particularly difficult for me is dealing with it in my mind, as it’s a small distinctive asset class of high quality companies. My two somewhat contrasting filters are the Charlie Munger type of good companies to own forever and most securities owned by portfolio managers with turnover rates in excess of 20%. (On average they hold their positions for less than five years.) One way to look at the capital preservation companies is that these are the positions I hope to hold for the future generation of the investment committees I serve and for the future generations of my family. On the capital appreciation side I expect market sentiment to become much more favorable to the stock, either because of general changes in attitude or changes specific to that name.

Divining Rods
Old farmers in the search of below surface water used a bent stick to find the critical element necessary for success. Most professional investors use numbers. That is why I was delighted to see Jamie Dimon’s 74-page shareholders’ letter in the JP Morgan Chase annual report, where he made the following statement “earnings is not a perfect measure of performance and economics”. Despite all the billions/trillions of dollars being spent on technology by JP Morgan and many others, as in “the world is going digital”, basic human processing remains an analog art. (I suspect the utility of earnings estimates was downgraded when analysts switched from slide rules to calculators. Slide rules produced good approximations, not precision certainties.) Jamie’s letter is full of what of they are doing for people, including clients, customers, employees, local communities and sovereign nations. This is how he is building what he calls “a financial fortress”. (I wish he would have used another term for such a high-quality organization. A study of military history shows that the strongest fortress falls due to the actions of those within the fortress, causing internal deterioration.)

One fallible measure of effective capital preservation is the company’s lowest stock price relative to tangible common equity. For example, the lowest price for JP Morgan was above its tangible common equity. This is more difficult for a service company and the number of contractual subscribers might be used as a measure in some cases.

Quality Can Be Expensive
Most of the time the US stock market goes up and the market often prices quality at a significant premium to its “bear” market price. Therefore, purchasing a new high-quality name could lead to a significant drop before a new bottom is established. However, if the purchaser is interested in long-term capital preservation, the odds are good that future cycles will give the investor substantial rewards for many years and decades into the future.

Why the Focus on Bear Market Prices?
The job of a prudent manager is to always be aware that markets can surprise on the downside. This is particularly true when sentiment is rising. The following news elements make me cautious:

1. The current low double-digit stock market gains are much larger than current earnings projections for 2019, suggesting the bull market will continue into 2020.
2. Volume is dropping as prices rise. 50 of 72 index prices rose last week and bond prices weakened.
3. Barron’s Cover “Is The Bull Unstoppable”
4. Barron’s article headline “There’s no Expiration Date on this Bull Market”
5. The risk of professional investors actually running companies may be growing, in spite of poor past results.

Question of the Week:
How Do You Identify Quality?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/03/investment-committee-and-investors-be.html

https://mikelipper.blogspot.com/2019/03/the-actively-worrying-classpassively.html

https://mikelipper.blogspot.com/2019/03/long-term-trends-may-not-be-friend.html



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Copyright © 2008 - 2018
A. Michael Lipper, CFA

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Investment Committee/Investors Prepare for Mistakes - Weekly Blog # 570

Mike Lipper’s Monday Morning Musings

Investment Committee/Investors Prepare for Mistakes

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

     
                               

Bright People Are Sometimes Wrong

I have assembled and often chaired investment committees of bright, experienced investors. I have been curious as to why these bright investors make unexpectedly bad judgements. Individually, they have a history of making good choices in terms of securities and the timing of their transactions. I bring this up as we approach a general market turning point. I am totally convinced that we will see record high prices for the major indices and I also have confidence that we will experience both recessions and substantial market declines. The order, timing, and magnitude of these are unclear to me. What I am sure of is that many investment committees and most investors will get their timing absolutely wrong!!!.

Why?

We are social people who mostly prefer to agree with others than to express a strident minority view. The group dynamic in most investment committees is to move to a unanimous decision. Unless we have very deep-seated opinions there is a tendency to go along with the sensed majority view, despite our own private opinion which may be better. This tendency has been labeled the “Abilene Paradox”. I suspect that this is one of the reasons that political pools have proven to be inaccurate. One can often sense the answer the questioner wants to hear and we have sympathy for those who ask.

Current Factors

Double digit gains were achieved by the major stock market indices despite the global slowing of economies. The gains if repeated would result in record price levels, led quiet possibly by the NASDAQ Composite, the most volatile of the major stock indices. This volatility could be driven by the larger tech companies or less capital being committed to over-the-counter market making.

The latest Atlanta Fed Real GDP fan chart estimate ranges from under 2.5% to under 1%, reflecting market fears.

China appears to be the most important driver of global economic growth. Some believe changes in Chinese policies are having a bigger impact than the Fed. In part this is true because interest rates driven by the Fed are currently in the mid-range. They have not gone high enough to attract savings (4%) or low enough to spur a declining economy.

One large fund of funds manager has re-juggled its list of managers in favor of concentrated “high-conviction” managers. Others are adding leverage to their portfolios to overcome low returns. From a market viewpoint the combination of leverage + volatility = dynamite.

Helpful Hints from Mutual Funds

Mutual funds are now required to show their best and worst quarters. These are often next to or close to each other. Often the magnitude of the gains and losses when linked together almost cancel each other out, although sometimes it may take two up quarters to recover the losses from the bad quarter. If the percentage gains and losses are large, it is an indicator that the fund is volatile.

The coverage of mutual funds can be misleading, as media and sales efforts focus almost exclusively on the best performers in relatively short time periods. The leaders and laggards are often highly concentrated in terms of the number of issues held, giving the impression that these mutual funds are bought for speculation, although that is not always the case.  

The vast majority of the equity funds are in just four investment objective categories and are listed below in descending order of assets, which also appears to be at increasing levels of perceived risks as you work your way down the list: 

Growth & Income    $4.27 Billion  

Growth              3.84                 

International       2.48                 

S&P Index           2.19                 

The first three investment objectives carry cash to meet extreme redemption needs and opportunity reserves. The biggest use for these funds is to meet retirement and for estate building purposes. Most redemptions are caused by life changes. Index funds always have no cash and buy the most popular stocks.

Turning Point Reactions Produce Relatively Small Gains and Large Losses

Historically, momentum becomes the enemy of capital preservation when we near peaks and troughs, unless an investor possesses trading skill. Investment committees at this juncture become captives of the “Abilene Paradox”.

Don’t say that you weren’t warned, but good luck and stick to your convictions.

  

Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2019/03/the-actively-worrying-classpassively.html

https://mikelipper.blogspot.com/2019/03/long-term-trends-may-not-be-friend.html

https://mikelipper.blogspot.com/2019/03/the-top-before-big-top-weekly-blog-567.html

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The Actively Worrying Class/Passively Investing Holders - Weekly Blog # 569

Mike Lipper’s Monday Morning Musings

The Actively Worrying Class/Passively Investing Holders

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

       

                                  

In many sporting events and wars the side that talks most often exhausts themselves, or at least is constrained by their public statements. The theoretical wall of worry that bull markets climb is constructed with bricks of displayed worries. Currently, particularly for some this weekend, there is a lot to worry about. The pundits in the media and salespeople are clever annunciators of worries. As both a student of words and investors actions, I have noticed relatively few actions on the part of investors. What follows are two worries linked to two true concerns and one very current display of actions.

I share military service with the two President Bushes (Captain, USMC) and the current President, who had a secondary school military experience. Those military experiences arouse strategic considerations that all too few are paying attention to, some that threaten peace.

China
In the early part of the 20th century there was much written about global geopolitics. The German general staff believed that whoever controlled the landmass of continental Europe and Asia would control the world. US Admiral Mahon believed that whoever controlled the oceans would control the world. These beliefs are still very active in the minds of global leaders and explain much of today’s news.

Some of the investment managers we use have for decades invested in China. They believe the current government does not have territorial ambitions, but economic ambitions to be the respected as an economic leader of the world. They are very anxious to reach this point in order to avoid becoming too old before they become, on a per capita basis, rich. As is often the case, people look back on periods where things were better for them. The ancient silk road brought acknowledgement of the riches of China to the rest of the known world. China was the most advanced country in the world in terms of economics, technology, and culture.

The current Chinese leadership is rebuilding the silk road with the help of its neighbors, a land route for rail and road from China to Europe. In addition, they are equally busy building a series of sea routes and friendly ports through the South China Sea, across the Indian Ocean, and up the coast of Africa into Europe. This week’s Chinese visit was intended to establish closer trade relations between Italy and China. Remember the return of Marco Polo to Italy from China and the enormous wealth a few Italian cities earned from their trade with China. (Many years later Boston generated some of its wealth through the Clipper ship trade with China. Taking care of the wealth of successful sea captains while they were gone for periods often longer than a year was the foundation of a good bit of the trust business controlled by Boston law firms, who had their own money managers.)

I don’t know what the current President learned at the New York Military Academy or at Wharton (University of Pennsylvania), but I can share my views. The current so-called trade war with China is an attempt to modify China’s long-term strategic thinking. The first objective is to insure freedom of naval passage in the South China Sea, through which a great deal of China’s strategic imports must move. Europe is increasing its reliance on Chinese imports to meet its needs, including its technology needs. The future of technological dominance is even more important to President Trump than the naval considerations.

While China can produce low level semi-conductors, they must import the most advanced semi-conductors to meet both their industrial and military needs. These issues will soon play out in the control of space and become the point of maximum disruptive power. Thus, it was not at all surprising that the White House sought to establish a sixth independent military service, a space force. This initiative was defeated on “The Hill” and it will now be incorporated within the Air Force. In my opinion, tariffs were a means to get the Chinese to the table to resolve more strategic questions.

Answers to Productivity
Some of the best scientific and political brains have been struggling with the fact that US productivity appears to be stuck at a low level of about 1% per year. In past periods when the US was growing in the mid-single digits, productivity was growing at similar levels and for awhile reached 7%. There are at least three reasons for the slow growth. The first ties back to my education in the US Marine Corps.

For the most part the Men and women who join The Corps are no different than the general population, they are just trained better. From the very beginning they are trained in leadership, which was why I wanted to be a Marine. My desire to learn leadership skills originated one summer when I was in high school. I had a manual job in a small laboratory where I heard of the lack of leadership in the low and middle management tiers of large US companies.

A survey of US workers states that no more than 30% are engaged in what they are doing on the job. Gallup and others believe that the main fault lies with the immediate supervisor of the workers. Contrasting that with my training as a junior officer in The Corps, we learned that battles and tasks are often won by the leadership of the non-commissioned officers. These corporals and sergeants lead by example, by training, by their own discipline, and by caring for their troops. As officers our job was to support the NCOs and our Marines in any way we could. Those attitudes are not present in the supervisory workforce today. Workers need to be inspired to do their jobs better and help others in the group so that become promotable.

Another way to improve productivity is to see the challenges of automation. There are far too many articles about people being replaced by machines, an issue first raised by the Luddites attacking automation in the spinning mills. Machines are good at repetitive functions but require people to figure out how they should best be used. Like identifying the next steps in the process and how to create the need for new products and services. Perhaps there are unmet needs to re-educate workers and users, both for existing products and services and for those of the future.

A third answer is perhaps the single best way to increase productivity, through better schooling and education. The distinction between the two is that schooling is what you are taught, education is what you learn most often from life experiences outside of school.  We need to have people recognize that everyday experiences can lead to an education. The idea of a workless retirement is no longer relevant for most, as not working leads to increased spending. There is still important and fulfilling work in the charitable sector that is necessary for our society to progress.

After Worrying, Probably Do Nothing
If one looks at the last 3 days of the previous week, one can see reasons for worry. The table below shows the closing prices, price changes, and volume for Moody’s, a stock owned in our financial services fund.

Date    Price Change    % Change    Share Volume    Last Price
3/20       -1.38          -0.77       1,269,927       $177.25
3/21       +4.74          +2.67       1,700,888       $181.99
3/22       -4.10          -2.25         987,175       $177.89

Interest rates generally drive potential opportunities for Moody’s ratings on new bonds and credit instruments. On Tuesday the 19th the Federal Reserve said it was not going to raise rates, suggesting more money could be raised. By the next day some had concerns that the Fed, by not raising rates, was worried that the economy was closer to a recession. The following day sentiment changed again and the market viewed things more positively, leading the stock price to move to a new 2019 high on much better than average volume. Only to be followed by a pull-back on Friday to Thursday close, but with only 58% of Wednesday volume.

One could interpret from this tiny sample that while there are lots of things to worry about, most investors will continue to hold on to their long-term stock investments, at least for the moment. Because of the announcement on the Presidential investigation today, I expect that those with a strong view will react on Monday. My guess is that whatever happens there will be a reversal later in the week.



Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2019/03/long-term-trends-may-not-be-friend.html

https://mikelipper.blogspot.com/2019/03/the-top-before-big-top-weekly-blog-567.html

https://mikelipper.blogspot.com/2019/03/2-speed-vs-2-directions-old-better-than.html




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Copyright © 2008 - 2018
A. Michael Lipper, CFA

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LONG-TERM TRENDS MAY NOT BE A FRIEND - Weekly Blog # 568

Mike Lipper’s Monday Morning Musings

LONG-TERM TRENDS MAY NOT BE A FRIEND

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

                     
     

“Big Mo” in the political world, “The Trend is your Friend” in the commodities world, and momentum investing are beliefs in continuing that which is into the future. Certainly, various media pundits stress current trends. Salespeople of all stripes find it is easy to sell their wares by highlighting current conditions. As a contrarian investor I am delighted to see great levels of enthusiasm for the currently popular, because it leads to significant mispricing of both rewards and risks, creating opportunities for the careful investor. For those swept up in what is currently popular, it should be a well-earned learning experience.

Faulty Long-Term Predictions

This week there were two very relevant notices in the press. The first was a statement by Ajay Sing Kapoor, an analyst at Bank of America/Merrill Lynch. The statement said “There is really no permanent trend just lazy intellectuals confusing a long cycle for a perpetual-motion machine.” This is a useful insight in the climate change debate. One of the best market analysts I know grew up on a farm which he has owned for 30 years. He mentioned the feast and famine cycles experienced while living there, much like the biblical seven fat years followed by seven lean years. 

The belief in long-term trends is present in today’s investment selection, which focuses of selected factors based on selected histories. The strongest of these is the belief that changes in earnings per share will dictate the price of the shares. This was true even when I was a junior analyst at a trust bank, where investment leaders used the change in reported earnings per share to make investment decisions. Even then I was suspicious, feeling that reported earnings were the result of both controllable and uncontrollable forces. It is only later that I became more conscious of the changes in Generally Accepted Accounting Practices (GAAP). Today, earnings report releases emphasize “adjusted earnings, adjusted operating margins, adjusted profit margins and even adjusted revenues”. The SEC has mandated that these reports must also show the results according to GAAP, but they don’t  highlight the fact that almost every year AICPA makes changes to GAAP. Corporate data complements government produced data as critical inputs to thinking on the economy according to Jim O’Neill, the former Goldman Sachs partner and global economist who coined the “BRICS” term for the rapidly developing emerging markets countries. He writes, “Though economics aspires to the rigor of the natural sciences, at the end of the day it is still a social science.” Thus, the specific numbers produced by economists are kidding us with their precision, particularly when they are expressed with decimals.

An Improved Fan Dance

If the base data is questionable, its use as the foundation for future prediction is extremely questionable. Consequently, The Bank of England and some of the US regional Federal Reserve Banks are showing charts using the most current or corrected datapoints, then adding a fan like wedge showing the range of future predictions.  My natural skepticism questions if the wedge is too narrow. I can accept that a narrow fan probably includes most of the probabilities utilizing a single up and down standard deviation. However, as an investor I like most others feel much worse after a decline than a pre-tax gain. I would much prefer a wider wedge that includes the reasonable possibility of two or three standard deviations. (I believe that both long-shots win and racing accidents happen on occasion, depriving the best horse from winning.)

Jason Zweig on the Wrong Long-Term

The second important item in this week’s press is a column by my friend Jason Zweig. He cautions against investing in companies that are building for the long-term, properly concerned that the focus on long-term investing can lead to the mistaken allocation of resources. Tech companies spend substantial capital on new facilities and equipment for future markets that might not evolve. Think of the engineering and construction geniuses responsible for the construction of the Egyptian Pyramids. The pyramids were monuments to the rulers while living, as well as in their after-life. I am much more interested in the long-term development and acquisition of talent, including the building of multiple generations of leadership at all significant levels. 

Investing for the Long-Term

I have devoted most of my investments to the long-term and where appropriate for my clients I have done the same. While this on average generally means a low turnover of securities and funds, it is not a lock-step process of holding regardless of current input. It requires careful examination of current information versus long term perspectives, both of the specific investment and its place in the portfolio, as well as any changes in the needs of the beneficiaries. I accept the cyclicality of both the markets and my ability to correctly analyze the inputs. I often expect to be premature and less often to be wrong. My long-term attitudes are derived from the study of some of the best investors as far back as I have information. In general, these attitudes have been good for my accounts and family over time.

Mid-Term Platform or Lid?

Each week I look at the investment performance of mutual funds around the world as a good representation of the results of managed money. This week I paid attention to the average returns of US Diversified Equity funds for the five years ended this week. The period included the final years of the past administration and the first couple years of the present one. The importance of politics is questionable. The twenty-investment averages for the five years generated an annualized compound growth rate of +5.69%. This included some extremes on the upside: large-cap growth funds +12.13%, S&P 500 index funds +10.72% and multi-cap growth funds +10.16%. On the down side there were dedicated short bias funds -19.35% and alternative equity market neutral funds -0.74%. These results suggest that large-cap tech companies produced a disproportionate portion of the gain and that being out of equities was a loser. 

Five years is a little longer than the average US stock market cycle and roughly equates to the presidential cycle. Being a contrarian I would not expect the two extremes to repeat over the next five years. The extreme contrarian would examine the funds that produced negative results feeling they could be the leaders at some point. In that vein I would be scanning for any indication that things are changing for the better for commodities funds, particularly those involved with different aspects of energy and agriculture. I don’t currently see a catalyst, but I can afford to be late as I suspect that most of the selling in these sectors is over.

Short-Term = Confusion

As is often the case the future direction from current conditions is not clear to me. Banks do not appear to need deposits to make loans as the interest rate offered on average is 0.59%, down from 0.61% the week before and its recent cycle high of 0.63%. Lack of new loan demand is not encouraging. The latest survey sample of the American Association of Individual Investors (AAII), a very volatile measure, shows the three alternative predictions for the next six months are all between 31% and 36.5 %. On a more positive note, the roster of price moves in the Weekend WSJ showed 64 out of 72 being positive. Of the 25 best performing funds for the week, 14 were growth funds and 3 were health-oriented funds.

The one certainty after a period of level market performance is that there will be a breakout on the upside or a breakdown, possibly both, based on  higher volume and enthusiasm.

Another Favored Myth Destroyed

For many years during a US recession Americans talked about moving to Australia with their US acquired skills. Very few did, but it was in the back of their minds as an economic escape. In the nuclear age several Americans thought that the safest place to live with their families was the South Island of New Zealand. The tragic events of this week have shown that there is no practical place to escape. We are going to be forced to deal with present and future problems where we are. The destruction of myths often leads to the recognition of the benefits of where we are and focuses our attention on making our lives and investments better.          

  

Did you miss my past few blogs? Click one of the links below to read.

https://mikelipper.blogspot.com/2019/03/the-top-before-big-top-weekly-blog-567.html

https://mikelipper.blogspot.com/2019/03/2-speed-vs-2-directions-old-better-than.html

https://mikelipper.blogspot.com/2019/02/lessons-from-warren-buffett-and-italian.html

Did someone forward you this blog?

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

Copyright © 2008 - 2018

A. Michael Lipper, CFA

All rights reserved

Contact author for limited redistribution permission.