An Awkward Moment with Frustration not Exhaustion - Weekly Blog # 591

Mike Lipper’s Monday Morning Musings

An Awkward Moment with Frustration not Exhaustion

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

Trying to develop a sound long-term investment strategy at any time is difficult, as most of the time we are clearly not at a top or bottom of a significant market move. We wander along an uncertain path to an eventual turning point, but each day, or in my case week, I must read the current sign posts to decide whether or not to change direction on the path I am traveling. Currently, there are three difficult choices to select from:

1. Stay reasonably fully invested in the upward sloping secular trend, accepting that there will be periodic cyclical movements.
2. As the opportunities and risks in today’s world are not the same as in the past. We should become increasingly defensive by building meaningful cash reserves.
3. Prepare for global policy mistakes that causes devastation.

I put the chances of being correct for each of these choices at 65%, 30% and 5%, respectively. On an overall basis I would improve my odds by sub-dividing the portfolio into timespan segments and periodically re-weight the commitments to the segments based on both perceived future conditions and the changing needs of the beneficiaries.

These three working conclusions are based on the following inputs:

Secular Continuation with Bouts of Cyclicality

• Most of the current volume is being generated by those that have a short-term time horizon. They are being whip-sawed by politically oriented news which is generating a lot of frustration. However, it is not generating the quantity of transactions representative of final exhaustion, or a complete retreat from participation.
• Nevertheless, traders are making decisions based on liquidity e.g. compare the ratios of advances to declines on the NASDAQ 211/314 vs. NYSE 411/229. (In general stocks on the NYSE trade in greater volume than on the NASDAQ) 
• Net flows into and out of ETFs shows short-term withdrawals this week. The two largest withdrawals totaled $4.6 Billion and the two largest net purchases totaled $1.2 Billion. The S&P 500 and MSCI Emerging Markets were sold and Consumer Staples and Gold were bought. 
• Even after Friday’s drop of 3% for the NASDAQ it is till up +16.63%, whereas the DJIA is up only +9.87%. Both gains will probably be larger than the total earnings gains for 2019, suggesting the market is looking for a good 2020.

Game Changers

• Lower interest rates and less binding loan covenants are likely to cause more bad loans.
• Only 42% of weekly prices are rising. Could we have deflation in goods and inflation in services and imported goods?
• Last week the interest rate offered to depositors went from 0.65% to 0.73%, suggesting that banks are increasing lending in face of slowing demand for products and services.

Global Mistakes

• The battle for dominance is essentially driven by defensive needs, not land or market dominance.
• The Chinese have been thinking in these terms for more than a thousand years. The earliest example of their well-developed thinking is in the writings of Sun Tzu entitled “The Art of War”. Jessica Hagy has produced a book that visualizes Sun Tzu’s thoughts. These should be understood by other world leaders and are shown below:
• Hold out baits to entice the enemy
• Feign disorder and crush them
• If your enemy is secure at all points, be prepared for him. If he is in superior strength, evade him.
• If your opponent is temperamental, seek to irritate him. Pretend to be weak, that he may grow arrogant.
• If he is taking his ease, give him no rest. If his forces are united, separate them.
• Attack him where he is unprepared, appear where you are not expected.
• These military devices, leading to victory, must not be divulged beforehand.
• The general who wins battles makes many calculations before a battle is fought.
• The general who loses a battle make but few calculations before-hand.

The Asia Times has an article entitled “China now has edge in Indio-Pacific”. It is based on a think tank report from an Australian group named United States Studies Centre. The study raises the question “Could the era of US military primacy in the Pacific be over? Their view is that internal conditions within the US suggests that it will not fully fund the needs of its National Defense Strategy. At the same time China is building a capability which in a surprise attack would destroy or cripple some or all of the US’s Western Pacific main installations in Guam and Japan. (Interesting that the report did not name our forces on Iwo Jima and in the Indian Ocean.)

My Point of View
As a former electronics, aerospace, broadcasting and conglomerates analyst, I have seen the power of small electronic components change massive companies and markets. The current “trade war” was designed to protect the primacy of our semiconductor technology, which is critical to both US and Chinese defense efforts. To paraphrase Admiral Alfred Thayer Mahan’s statement of Who controls the Seas, controls the world. I believe the two Emperors of China and the US are acting as Who controls (leads) semiconductors and related technology controls the defense of their countries.

An Important Question
Considering how long value focused managers have suffered, can we build portfolios that are able to survive a similar period, regardless of our investment strategy? Any thoughts?



Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/08/short-term-recognitions-plus-longer.html

https://mikelipper.blogspot.com/2019/08/sentiments-approaching-reversal-points.html

https://mikelipper.blogspot.com/2019/08/is-last-week-significant-weekly-blog-588.html



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A. Michael Lipper, CFA

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Short-Term Recognitions Plus Longer-Term Work - Weekly Blog # 590

Mike Lipper’s Monday Morning Musings

Short-Term Recognitions Plus Longer-Term Work

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

Short-Term Recognitions
We have reports of financial cycles since the beginning of recorded history and are always in some phase of a cycle. The keys to financial survival and future success are to recognize where we are in the present cycle, something which is almost always difficult to do emotionally. It is tough to label the current down draft. Is it a trading incident, a correction (normally about 10% from peak), the beginnings of a “bear market” (normally about 20% from peak), or a major crises that occurs once in a generation, with a decline of 50% or more? Only time will tell which of the alternatives describe our immediate future.

In the current US stock market most of the trading volume is from groups that are short-term oriented. With this orientation they tend to react to changes in sentiment rather than long-term trends. In the current market environment, I tend to focus on price changes for the NASDAQ Composite Index, which has risen the most of the three main stock market indices. The Composite includes a fair number of tech stocks and companies that provide services. Both of these have been growing their revenues faster than the industrial companies in the Dow Jones Industrial Average (DJIA) and the more broadly invested Standard & Poor’s 500 Index. (If it weren’t for the weak performance of the mid/small mixed financial services companies in the NASDAQ Composite, the lead would be even larger.)

Viewed in this light, the most recent weekly difference in the number of stock prices rising or falling may be instructive. The New York Stock Exchange (NYSE) had 373 gainers and 440 losers, whereas the NASDAQ had 203 gainers and 516 decliners. The NASDAQ is only off -5.21% from its peak, half-way toward being labeled a correction. Clearly one goes through each gradation until the ultimate bottom is reached. Whatever the appropriate level, some further fall is a reasonable expectation.

As I and others have stressed, the current market is led much more by sentiment than the investment fundamentals found in financial statements. Nevertheless, one should recognize that sentiment can impact prices for securities, currencies, and commodities. Each week The Wall Street Journal (WSJ) shows the weekly price movement of 72 items. Like many sentiment indicators, the rises and falls are normally bound in a 60/40 range. This week only 30% of the prices rose, with 70% declining. If attitudes toward prices remain outside of their normal range, it could be significant and could point to a larger decline than a mere correction.

One statistical series that may be misinterpreted is the constant sale of stocks by well-known value investors. These trimmings are being viewed as disenchantment with the holdings and while some disenchantment may be true, before reaching that conclusion it is necessary to review their record of inflows and outflows. When these previously successful investors are forced to make a partial liquidation they often choose among their most liquid positions, not necessarily their weakest. This has been the pattern for many quarters. If the downturn becomes more pronounced the time for trimming will likely end and favor totally selling out of selected names that may not have the same chance of price recovery. This typically happens near the end of market declines.

Time to Build Research Lists
In past market declines my fellow analyst friends would have lists of names and prices they wish to recommend to clients and/or purchase for themselves. All too often these lists are not executed due to the low-level of confidence in the new analytical work being done. It is with these thoughts in mind that I am now suggesting that this is the time to begin in-depth work on new names, not in portfolios or coverage patterns.

The first place I would look for candidates is the mutual fund investment objective averages. There are 19 fund averages that have risen less than 6% this year and 4 that have produced negative returns. These are:

Agricultural Commodities     -8.88%
India                        -5.58%
Natural Resources            -5.26%
Base Metals Commodities      -2.80%

Apart from the funds focused on India, the other three are classic supply/demand vehicles which are now suffering from insufficient demand for the current supply. We know from history that these conditions lead to future supply being curtailed by the withdrawal of some of the participants, although with both population and wealth growth there is little question that future demand will be higher than today’s level in the future.

India is a fascinating opportunity currently experiencing internal political issues. Nevertheless, it is the fastest growing major economy in the world. Faster than China and within twenty years it will have a bigger population too. Fourteen of the remaining investment objectives focus on international investing, many with an Asian mandate, highlighting two possible attractions. The first is summed up in a quote from the Chief investment Officer of Matthews Asia. “Growth that depends less on trade and more on continued savings, efficient investment, and institutional reform. All things to which Asia remains committed.” For a global investor, the largest risks is a decline in the value of the US dollar relative to other major currencies. (This may also reflect a relative decline in the standard of living for many US residents.)

The only domestic oriented investment objective with a low year-to-date average return of +4.25% is Small Company Value Funds. As with other value-oriented investment objectives, performance has lagged most other groups for the past several years. These funds must meet redemptions by liquidating and dealers might not be willing to take their discard into their limited inventory. The three commodity types mentioned above will rise when their markets are dealing with shortages.

There is another category that at some point may include some real bargains, internally driven turnarounds. Internally driven turnarounds most often result from new leadership and the restocking of operating management with new talent. Introducing new products and services with attractive pricing will also help. Unlike the swing from oversupply to shortage, internally driven turnarounds take time and may attract short sellers who are not patient.

Investment Conclusions

1. Review your portfolio for those positions you want to own for the next bull market and dispose of the rest.
2. Start the lonely job of researching new potential holdings which are likely to be winners in the next new market phases.

Questions of the Week:

1. Are you prepared for a down market?
2. Are you looking for the next Bull Market Winners?  

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

https://mikelipper.blogspot.com/2019/08/sentiments-approaching-reversal-points.html

https://mikelipper.blogspot.com/2019/08/is-last-week-significant-weekly-blog-588.html

https://mikelipper.blogspot.com/2019/07/chinese-emperors-learn-all-roads-lead.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

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Sentiments Approaching Reversal Points - Weekly Blog # 589

Mike Lipper’s Monday Morning Musings

Sentiments Approaching Reversal Points

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

In the near future US stock market sentiment will approaching a reversal point.

Handicapping the US Stock Market
The art of picking winning bets at the racetrack is called handicapping. The betting goal is the same for long-term investors, to have more money at the end than when you started. Note, unlike baseball it is not the number of wins vs. loses. Both handicappers and investors recognize they will be wrong a percentage of the time, but in both cases success is measured by the number of dollars remaining at the end of the game, suggesting that in order to cover the losses gains will need to be larger. As the portion of the wins must be bigger than the average win, most successful investing involves a streak of contrarian thinking.  With that in mind I’ve laid out my view of the current level of the stock market.

As of August 9th, the three major stock market indices have declined modestly from their recent record levels. (S&P 500 -3.54%, DJIA -3.92% and NASDAQ -4.45%) None of these are even near a -10% correction, a -20% bear market, or a generational decline of -50%. Even including the worst week of the year, the three indices are up between +15.87% and +23.14% from the lows generated on January 3rd. However, the weekly survey of sample members of the American Association of Individual Investors (AAII) shows that only 22% are bullish for the next six months, with 48% being bearish. These percentages are historically extreme. A somewhat more nuanced view is expressed by bond and bond fund investors that also indicates caution. For the week ended Friday, yields on a Barron’s list of high-grade corporate bonds yields fell 11 basis points vs. only 4 bps for a similar list of intermediate credits. (Remember, a fall in yield means prices rose, indicating increasing demand.) During the trading week ended Thursday, General US Treasury Bond funds rose +2.25%, while the average High Yield fund declined -0.48%. It’s interesting that in a week where the Fed lowered interest rates by 25bps, the flight to safety pushed US Treasuries higher. 

Like Charlie Munger and Warren Buffett I am not a big fan of book value as a measure of operating success, although it is somewhat useful as a gross comparative measure. Comparing last week’s market to book value with those of a year ago, the DJIA declined very slightly, while the S&P 500 is the same as a year ago. Thus, the market is not grossly overpriced despite second quarter earnings being flat. According to analysts, the current quarter is expected to show a 1-2% decline that will be made up in the fourth quarter.

However, there is still reason to be concerned. On a year to date basis mutual funds have gained 2-3 times their average rate of gain for the last five years. Additionally, they are producing gains that are higher than their very long-term rates of return. Funds limited to the largest stocks, both within the US and abroad, have gained +14.47% year-to-date on average, compared to their five-year average return of +5.77%. Multi-cap Funds, a group of funds without a size limit which often has some large caps, were up +13.74% year-to-date and +5.32% for the past five years. Funds focused mostly on US holdings did somewhat better than those invested abroad due to having more tech holdings and the long-term rise in the dollar.

Short-Term Investment Thinking
Just as the betting results on the most favored racehorses is not great because they rarely produce enough betting winners to cover losses, I am betting against both the AAII crowd and the buyers of US Treasuries. I would also not be surprised if 2019 ends with high single-digit equity gains. In most of our managed accounts I would not disturb the highly selected funds in our portfolios.

Caution: Healthcare Could Look Like Financial Services in the Future
Over my professional investment life the Financial Services business has been quite good to me and my family. However,  the average rates of return have not been as good as they were in prior decades. Looking at the structure of these businesses today, while the numbers are larger the number of people and firms have shrunk. The number of publicly traded firms has been cut in half. The rates of return are also smaller than what they were years ago. Perhaps the single best measure of the decline is that fewer sons and daughters of successful professionals and successful investors want to enter these businesses. In sum, I believe the percentage returns are smaller than those of past decades for most investors. There is a very real risk that the same trend will govern the Healthcare Industry.

As with the Financial Services business, the Healthcare business is already highly regulated by the government and it is likely to become more so. In both cases the purpose of government regulation is to make care available, better, and cheaper for the public. I have twin fears that it won’t happen. The first is a story in Sunday’s New York Times about an individual who went to Mexico for a knee operation  paid for by a generous employer funded insurance plan. This is just another example of what is now called medical tourism, in this case to lower costs. Non-US citizens, both the very wealthy and the very poor, are entering the US for healthcare services they can’t get at home. For many years US residents have been traveling to other countries to get medical treatments not been approved here. These trips, along with the number of Canadians in our hospitals, demonstrate that patients will travel to get what they believe to be better or cheaper medical care. They may or may not get it.

What has likely caused the increase in medical tourism is the combination of increased regulation and the limiting of profit making of doctors, hospitals, insurance companies, pharmaceutical companies and all their suppliers and servicers. As an investor, as well as portfolio consultant to a hospital, I have looked at their financials. The good ones are reasonably profitable, but increasingly many are not and therefore  one needs to look beyond the dollars of profit. The first ratio to consider is profit relative to investment. Perhaps more important, is their perceived ability to pay dividends to their owners. For the most part these organizations feel compelled to reinvest their so-called profit into their activities. In many ways I do not consider retained earnings as current profits, because as an outside investor I can’t spend it.

As someone who has a large family dependent upon me to pay some or all their medical bills, including insurance, I would appreciate lower medical costs. It is important to understand that insurance is temporary risk shifting, favoring long periods of paying premiums directly or through the workspace. In the end my real desire is for others to have the lowest costs, but I want the best care for my family and the best often includes the new best drug or procedure. My fear is that as we restrict profitability in the healthcare system we won’t get the lifesaving or life betterment new drug or procedure quickly enough.

Just as we are well served in the financial services businesses by an appropriate level of profit, we need to ensure that the healthcare system can do its job of making our lives better.   


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

https://mikelipper.blogspot.com/2019/08/is-last-week-significant-weekly-blog-588.html

https://mikelipper.blogspot.com/2019/07/chinese-emperors-learn-all-roads-lead.html

https://mikelipper.blogspot.com/2019/07/us-stock-markets-new-highs-misleading.html



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

Copyright © 2008 - 2019
A. Michael Lipper, CFA

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IS LAST WEEK SIGNIFICANT? - Weekly Blog # 588

Mike Lipper’s Monday Morning Musings

IS LAST WEEK SIGNIFICANT?

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

There were some clues this week as to the possible future direction of the US stock market and the likely leadership for various future periods. Both the S&P 500 and the NASDAQ Composite had their single worst week of the year. I view the performance of the NASDAQ as a better predictor than either the S&P 500 or the Dow Jones Industrial Average (DJIA). The gains from the common low point of the year on January 3rd through this past Friday were: NASDAQ +23.83%, S&P 500 +19.78%, and the DJIA +16.74%. This order might be representative of the level of speculation, or at the very least the reverse order of dividend yields.

It may also be instructive to look at the number of new highs and lows for the week. The New York Stock Exchange registered 603 new highs and 250 new lows vs. the NASDAQ’s 322 new highs and 337 new lows. From this data one might conclude that this week’s decline was more a function of correcting from recent enthusiastic gains rather than representing a fundamental change in direction or future leadership.

Possible Causes for The Decline?
On July 31st the Fed’s announced that it was dropping interest rates by 25 basis points. The market was up after the announcement but turned lower during and after the news conference and then fell for the next two days. The NASDAQ had a ratio of losers to gainers of 1.91/0.73. Why? The following list might suggest some reasons:

1. Buy on the rumor and sell on the news is normal.
2. Disappointment that further interest rate declines were not identified as likely.
3. Because of the growing number of consumer and commercial credit extensions, rates should be rising to discipline the market.
4. China’s leadership is in no hurry to address trade tensions while increasing control over all elements of its society.
5. Disappointment with the two Democratic candidate television debates.

The first possible cause is a normal trading reaction. The second is mainly a concern for rate changes during the next 12 months. The third is a concern as to the depth of the next recession. The fourth and fifth causes might impact not only the next presidential election, but also the conditions during the next presidential term.

If only one of the five is important a single portfolio structure can be created. If more than one is important, it reinforces the need to subdivide one’s assets and liabilities into separate timespan portfolios, which we can help construct. For example, if one looks at various slices of the S&P 500 for the last month, the order of the four best performing slices were: S&P 500 Enhanced Value, Value, Growth and Quality. (We have maintained that value-oriented portfolios might perform relatively well coming out of the next recession. In anticipation of this, at least one manager we follow used the brutal decline in the fourth quarter of 2018 to buy some bargains and then used the first quarter of 2019 to lighten up on extended growth companies.) If one wishes to look for possible dramatic turnarounds, the worst mutual fund investment objectives this year through Thursday were the international value fund categories. They have generated average gains between 5% and 7% vs. gains between 23% and 28% for domestic growth oriented funds.

Not Market Timing
Market timing is a process that requires making three decision in a row. The first is to sell. The second is where to place the money in reserve, and the third is the new buy. The odds of making three correct decisions in a row is very difficult and only a few investors can achieve it. The biggest mistake is often made with the reserve element, as cash usually becomes too comfortable and delays re-engagement with risk. The third, which is the most difficult, is to choose something sufficiently different from the investment that was sold.

Further, market timers tend to move the whole portfolio all at once. I suggest a gradual approach, which allows for confirming that the basic view has not changed over time. One of the advantages of using mutual funds as your preferred vehicle is that it allows you to focus on changing investment characteristics, something the funds themselves are generally not set up to do. You are taking advantage of their selection skills in rapidly building a sound portfolio.

Is the Past Week Significant?
I suspect it is an appropriate time to start to move the portion of your portfolio designed to make payments over the next five years or so. For longer-term portfolios this may not be the time to make moves, particularly for those investors that have at least ten years before needing to make payments. One should definitely be judicious in making changes in legacy portfolios.

   
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/07/chinese-emperors-learn-all-roads-lead.html

https://mikelipper.blogspot.com/2019/07/us-stock-markets-new-highs-misleading.html

https://mikelipper.blogspot.com/2019/07/twin-problems-not-enough-greed-and-too.html



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Copyright © 2008 - 2019
A. Michael Lipper, CFA

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Chinese Emperors Learn “All Roads Lead to Rome” - Weekly Blog # 587

Mike Lipper’s Monday Morning Musings

Chinese Emperors Learn “All Roads Lead to Rome”

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

Before focusing on the underlying geopolitical/economic elements in our current tensions, we should focus on the immediate signals highlighted below:

1. As of this week seven of the twenty-one US Diversified Equity funds averages and five narrower sector fund averages have gained more than +20%, including the average S&P 500 fund.  Years ago, a manager of a corporate defined benefit pension plan with an excellent long-term record had a tactical rule. In any year that he was up 20% he went to cash. This was not a market timing maneuver, he believed that earning two to three times his actuarial assumption was enough in any year. It didn’t warrant taking any additional market risk in that year. There would always be opportunities the next year, particularly if there was a flow of new money. Some investors should follow this approach with their equity investments today.
2. Many so-called balanced funds or accounts don’t like high quality bonds. What they are holding in their fixed income allocation is meant to cushion a fall in a declining equity market. However, their fixed income allocations have assumed considerable equity type risks in currencies, high yield, or credits with very light covenants. This is particularly worrisome when the proceeds of these issues are used for increased leverage, without any substantial new earnings power being generated. Thus, many portfolios marketed as conservative investments have more than stock price risks embedded in them. Michael Cembalist of JP Morgan Asset Management is particularly concerned about leveraged loans, which are 95% covenant lite in Europe.
3. Are we approaching a time where a radical change in thinking about future trends is required? Typically, many financial and economic organizations publish their mid to long-term forecasts over the next three months. They include forecasts on domestic and global GDP, rates of inflation, interest rates, market concentration and favored industries/individual securities. They are produced by learned individuals or teams and are based on the continuation of present trends. In other words, their forecasts are like the US Fed, “data dependent”. Odds are, many of these forecasts will be right in their extrapolations, with relatively low payoffs. They run the risk of a “Minsky Moment” after a long period of stable results. (A Minsky moment refers to a sharp decline in prevailing market sentiment and economic productivity after a long period of widespread optimism). I think we are due for such an occurrence, particularly in organizations headed by long successful leaders close to their last hurrah. Remember the planner’s curse, “Men plan and God laughs”. Looking at the composition of the Dow Jones Industrial Average, not one of the thirty names is from the original list. Even the S&P 500 index funds have annual turnover due to acquisitions or lost market capitalization. I suspect we are due for a series of unexpected surprises, suggesting that after the 2019 gains we should be willing to build opportunity reserves, not market timing reserves. A future blog will address market timing issues more fully.

“All Roads Lead to Rome” - What Chinese Emperors Learned
The critical lessons of geopolitics and their accompanying economics are driving our two modern emperors today, the leaders of China and the US. The first era they should recognize is ancient Rome, which turned the Mediterranean into a Roman lake. Their power did not rest solely on the strength of the Roman legions, but more importantly on the success of their engineers in building roads and water viaducts. These were critical in supplying their capital center with imports of grain and captured slaves.

Over the centuries the Mediterranean held the keys to other powers. It was the last leg in the importation of spices and other materials from the “silk road” to Italian City states. The 15th century Europeans realized the nautical/military power of the Chinese when their armed junks entered the old Roman lake. (Due to a sharp change in the attitude of the Chinese government, which recalled all of their navy and destroyed their ships, their Navy was largely destroyed). Soon thereafter the Dutch replaced the Portuguese as the suppliers to Europe for much of what used to come overland. The Dutch East India Company (English translation of BOR) built a fortified base in Indonesia and controlled the South China Sea and much of the Gulf of India.

These strategic lessons were not lost on the Germans. They believed that whoever controlled “The World Island” (EuroAsia including Africa) controlled the world. The US view was enunciated by Admiral Alfred Thayer Mahan. (When I first read his views at Columbia I did not realize that he had spent two years there before going to the Naval Academy.) His basic view was that he who controls the seas, main islands and critical ports, controlled the world. He was particularly sensitive to “property” between 30 and 40 degrees latitude.

Underlying tension between the US and China today
I have always believed the tariff issues with China and other countries were a way to get vital national securities issues on the table. Going back to the roads of Rome, it’s apparent an empire is vitally dependent upon imports of critical supplies. (To some degree imports are dependent upon the combination of capital transfers and money earned from exports.) Unlike the US, China is much more dependent upon the import of energy, very high-quality semiconductors, and similar items, many of which are imported through the South China Sea and related bodies of water. China feels that it is a national imperative to control access to their country. Even with a fully developed “one belt, one road”, the land route is insufficient. Officially, the US is for the international right of free navigation of all major water routes. Like the Soviet Union, China wants to escape encirclement. China recognizes that at some point it may have to fight its way out of a perceived trap. In the modern world one of the weapons of choice is technology, particularly advanced semiconductors. Both sides recognize that they have attractive internal markets for other’s goods, as well as capital that can be used for their own imports. 

Investment Conclusions
We should learn from both boxers and wrestlers. In terms of tactical investment decisions, be a counter puncher looking for the rare opportunity, but as a wrestler stay engaged and use the opponent’s weight as leverage at critical points. Bottom-line looking ahead, after investing focus on up-to-date strategies, successful investing.


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

https://mikelipper.blogspot.com/2019/07/apollo-11-investment-lessons-weekly.html

https://mikelipper.blogspot.com/2019/07/us-stock-markets-new-highs-misleading.html

https://mikelipper.blogspot.com/2019/07/twin-problems-not-enough-greed-and-too.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 - 2019
A. Michael Lipper, CFA

All rights reserved
Contact author for limited redistribution permission.

Apollo 11 Investment Lessons - Weekly Blog # 586

Mike Lipper’s Monday Morning Musings

Apollo 11 Investment Lessons

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

The incredible historic success of landing two men on the surface of the moon is being celebrated around the world. This coming Friday it will be celebrated at the Jet Propulsion Laboratory (JPL), which is very appropriate. As readers of this weekly blog appreciate, I often see investment implications from many different events and sightings. The investment lessons I perceive from the Apollo landing include:

Historic unspectacular beginnings
Learning from addressing other needs
Inexpensive early development
Appropriate skepticism
Passing on to others
Always looking for next steps
Exercising Leadership in big and small ways

Record high US stock market indices are like a successful rocket launch. In much the same way it’s very interesting that in the same decade Theodore van Karman joined the Guggenheim Aeronautical Laboratory at Caltech, Ben Graham and David Dodd were teaching security analysis at Columbia University. At Caltech, von Karman and his students experimented with rockets and in 1936 he founded Aerojet, followed by the founding of JPL in 1944. (By coincidence, in the 1950s I studied under Professor Dodd at Columbia and was one of the few analysts to follow Aerojet in the 1960s. In the 1990s I became a Trustee of Caltech, the manager of JPL for NASA.)

Historic Beginnings and Inexpensive Development
Professor von Karman’s work at Caltech and JPL led to two of the critical forerunners of Apollo, the Ranger and Voyager unmanned probes of the moon and solar system. Before sending a man to the moon there were two schools of thought.

1. An east-coast oriented solution using the power of solid rockets. This approach was based on using a team of German scientists transplanted to Alabama. 
2. Accomplish much the same scientific goals with unmanned, cheaper successors to the van Karman rockets patented in the 1930s. 

For media and political reasons, the more expensive solution was chosen. JPL probes however, were critical to the analysis that it was safe for humans to walk on the moon in space suits. The investment lesson from the above is that marketing needs often dictate major decision making. (One might question whether the current discussion on the appropriate role of the so-called independent Federal Reserve is similar, as it may be a jobs/votes decision rather than a safety and soundness choice.)

Appropriate Skepticism
 As our readers know, I have been skeptical of the recent performance of the three major US stock market indices, although my skepticism is not based on financial or economic fundamentals. My concern is that while most investors are in effect on the sidelines, the dominant traders are being driven by sentiment. Looking at the underlying market data there are a few items to consider:

1. The NASDAQ Composite has been the best performing of the three stock indices in 2019. Recently however, the ratio of new lows as a percent of total issues traded is meaningfully higher for the NASDAQ (6.84%) than the NYSE (4.67%)
2. In the latest week the S&P 500 fell -1.23%, which was more than the Dow Jones Industrial Average -0.65% and the NASDAQ's -1.18%. I suspect the differences are not primarily due to the components of the indices but to the nature of the owners that are selling. Institutions are significantly bigger owners of the S&P stocks and their need for daily liquidity looks to be higher, suggesting they see a need to lighten up on their equity commitments.
3. Of the 72 weekly prices tracked by Dow Jones, only 27 rose, or 38%. Not a harbinger of good future earnings.
4. The yields on different annual maturities of US Treasuries are not tied as much as to yield optimization strategies as they are to the needs of owners who must fill holes in their payment schedule. With rates so low and probably going lower, maturity/duration may become more important than yield, making Fed/Treasury management of the bond market more difficult.
5. It is popular to assume that net flows into mutual funds and other collectives are exclusively a function of performance or investment category selection. This does not appear to be the case in each and every portfolio and shows that some investors or their advisors are looking more deeply than just performance or labels. Nevertheless, the bulk of flows seem to be short-sighted or actuarially based. The real issue is the relative profitability of fund products for distributors. The distributors want to shorten the longevity of the holding period to fund new investments. (As this is a contentious view, I would be happy to discuss privately in terms of specific holdings.)

The French Come to the Rescue Long-Term
Considering MIFID II, there appears to be a trend to reduce the level of brokerage commissions going to firms for their research. While this is legally directed at institutions within the EU, regardless where they are transacting, some US institutions have also adopted these rules globally e.g. T Rowe Price. With a shrinking market for research providers, many are either currently losing money or expect to if they remain independent. Rothschild & Co just announced the acquisition of Redburn and they earlier took a position in Kepler Cheuvreux, historically a top research firm. Another French affiliated firm, AllianceBernstein, is reported to have purchased Autonomous for over $100 million.

A cynical view of brokerage firms and to some degree investment managers is summed up in the title of a book “Where are the Customers Yachts?”. When an investment manager buys a research provider they are betting that research is of value and will become more valuable when prices rise.

A third input long-term is the French President’s attempt to lengthen the period to retirement by two years to age 64. As many of you know, one of the reasons we invest in fund management companies around the world is that eventually either governments or the private side of the economy will address the growing global retirement capital deficit. In the US we are starting to see articles suggesting our social security system will begin to further ration Social Security payments in about 2034. (My own view is that with the increase in longevity we should have a minimum retirement age of 72. I agree with my long-term friend and fellow former board member of the New York Society of Security Analysts that one should never retire. That is my plan.)

Conclusion
Just as fifty years ago when Apollo 11 marked the beginnings of our exploration of manned space, the stock market will also soar to meet the needs of investors, particularly those for retirement capital management. It won’t be a smooth ride, but it will be easier with elements of good leadership.   



   
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/07/us-stock-markets-new-highs-misleading.html

https://mikelipper.blogspot.com/2019/07/twin-problems-not-enough-greed-and-too.html

https://mikelipper.blogspot.com/2019/06/reduce-investment-mistakes-with-deeper.html




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Copyright © 2008 - 2019
A. Michael Lipper, CFA

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Contact author for limited redistribution permission.

US Stock Markets New Highs Misleading? - Weekly Blog # 585

Mike Lipper’s Monday Morning Musings

US Stock Markets New Highs Misleading?

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

On Friday, July 12th, the three main indices for the US Stock markets rose in price to new highs. Historically, when markets rise to new highs,  people treat it as a reason to believe that further advances should be expected, unless that high marks the peak for some time. Because trading volume was lackluster, these highs were probably not the peak, but that could be misleading. (These are not political views.)

Performance Reviews
The gains achieved so far in 2019 may themselves qualify as a bull market, when measured from the lows suffered in January:

Dow Jones Industrial Average +20%
S&P 500 +23%
NASDAQ Composite +28%

Note, the NASDAQ led the other indices and was in many ways the leader of the market. Relative to the other measures the NASDAQ is much more technology oriented and also has a significant number of smaller banks and financials. It also includes a larger number of companies which are not profitable.

Market analysts have two other statistics they use to gauge the strength of markets and their sectors. The first is the number of stocks advancing versus declining. In last week’s trading there was a material difference, as shown below:

Market  # Price Advances  # Price Declines
NYSE          1683              1384
NASDAQ        1463              1836

Perhaps the greater number of declines in the NASDAQ was the result of it self-correcting . The smaller NASDAQ companies are generally more attuned to their domestic customers’ views and while revenues remain strong for most companies, some of their customers may be showing some nervousness about the months ahead.

The second set of numbers that market analysts review is the number of new highs vs. new lows, as shown below:

Market     # New Highs      # of New Lows
NYSE           449                87
NASDAQ         284               142

Many investors believe that most transactions these days are directed by trading-oriented groups, particularly Exchange Traded Funds and Exchange Traded Securities, most of which are listed on the New York Stock Exchange. Thus, traders of one kind or another are more important than long-term investors in terms of market impact. Consequently, current market moves are more likely to represent short-term thinking than long-term.

N.B. Disclosure - I was an electronic member of the New York Stock Exchange and a member of NASDAQ. Both the financial services fund that I manage and my personal accounts own shares in NASDAQ.

Other Indicators

• Mutual Funds – 15 (60%) of the top 25 performing mutual funds for the week were invested outside of the mainstream of the US stock market. The bulk being in energy, commodities, Latin America, and other natural resources, including precious metals. These bets are anticipating a change from the immediate past, where technology and consumer products drove the US stock market.
• Below Investment Grade Bond Credit Ratings - A cut in the ratings of any credits in this class has a price impact on most of the vehicles that are below investment grade.
• Singapore – Historically viewed as the investment jewel of the orient, their economy contracted for the second consecutive quarter. Singapore and South Korea are both being impacted by global trade tensions. However, because of their talent and government focus, I believe they will come out stronger after restructuring. Consequently, this current period could be viewed as an opportunity for long-term global investors.

Increasing Volatility
We have gotten used to measuring daily volatility in terms of price points and considering the high levels of the market indices and many stock prices, volatility is currently considered high. However, if measured in percentage terms it would be considered low to normal. Intra-day volatility should be measured from high to low, in order to show the intra-day spread. More importantly, in looking at the Congressional Budget Office’s study titled “The Distribution of Household Income, 2016”, I expect personal income volatility for all is expected to rise. This is due to federal tax changes and changes at the state and municipal levels. (These studies don’t track sales and use taxes instead. They are likely to rise with various models of VAT imposed.) In addition, as we restructure the global workplace more people are likely to get more variable pay, rather than the mostly fixed pay they get today. For many it will result in a pay increase, but it will also likely result in an increase in anxiety. Contingency savings should go up, but probably won’t.

Investment Conclusions:

1. The markets are changing in response to shifting global economic movements.
2. There is an increased need for broad diversification to manage the impact of surprises.
3. Change is the name for the arena of Opportunity.

Questions for the week:

1. What significance do you attach to the new US market highs?
2. What major changes do you expect to impact your portfolio?
3. For what changes should your Children and Grandchildren be prepared? 

   
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2019/07/twin-problems-not-enough-greed-and-too.html

https://mikelipper.blogspot.com/2019/06/reduce-investment-mistakes-with-deeper.html

https://mikelipper.blogspot.com/2019/06/our-investment-mistake-is-in-labeling.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.