The Biggest Risk We All Face - Weekly Blog # 674

 

Mike Lipper’s Monday Morning Musings

The Biggest Risk We All Face

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

Self- Inflicted Risk

While many try, nobody commands how we make decisions. That is why each of us are ingenious in building our own strict prisons. Our jailers are what we choose to believe or not believe. It is that process which leads to our single biggest investment risk: Conformation Bias. While we are very conscious of the endless sources of facts and opinions in this modern era, the way we deal with too much information is to ignore much and accept some of the inputs. 

I cannot improve on your own selection process but will attempt to aid you in assessing the strength of your convictions. In this way I hope to improve the consequences of deeply held beliefs. For centuries, most people held firm to the belief that we lived on a flat earth. The consequence of that firm belief led to the economic disadvantage of not finding other parts of the world and not understanding weather patterns.

With apologies to subscribers for another example of learning from my most important educational source, the racetrack. The ranking of other bettors’ beliefs before each race are the winning odds on each participant, measured by the number of bettors favoring a particular horse multiplied by the amount of money bet. The generally known percentage history of the most favored horses winning is way below half and closer to one-third. Few pay attention to the percent return on each successful horse, which tends to be much bigger. For example, in a race where the most favored horse pays off at even money, a bettor would cash a winning $2.00 ticket for $4.00. If a 10 to 1 shot is the winner, the winning $2 ticket receives $22, or 5.5 times the cash payoff of the even money winner. (The payoffs are after track fees and local taxes.) The job of a good portfolio manager, using this example, is to pick at least one of three races vs. the even money bettor.

In the long run it is more profitable to somewhat invest in greatly unpopular securities and funds rather than those that are popular, which is why understanding Confirmation Bias is so important.

A Self-Administered Test of Your Confirmation Bias

The following is a list of controversial statements, not necessarily my beliefs. There are six alternative buckets for your beliefs: Believe (80%-100%/40%-60%/10%-20%) and Disbelieve (80%-100%/40%-60%/10%-20%). Where appropriate, place the strength of your belief or disbelief in each of the columns, as shown in the italicized example below:

                                                                                                

                                                                                                                  10%-20%/40%-60%/80%-100%

Statement                                   Beliefs       Disbeliefs 

“Money is the Mothers’ Milk Of Politics (1) 80%-100%        10%-20%                                           

1. “Money is the Mothers’ Milk Of Politics   

2. Redistribute Capital to Redistribute Votes 

3. Need More Union Dues Contributions

4. Higher Taxes, Lower Growth

5. “Value” Better than “Growth” for 10 Years

6. Drawdowns 34%-49% (2)

Complete the table below by placing a check under one of the belief columns and one of the disbelief columns, answering for each of these six questions above. 

               Beliefs                        Disbeliefs 

      80%-100%  40%-60%  10%-20%      80%-100%  40%-60%  10%-20%

1.

2. 

3.

4.

5.

6.

1. A statement by Jesse Unruh, speaker of the California House and supporter of each of the three Kennedy Brothers.
2. In the last 23 years, the annual decline of the S&P 500 was -49% in 2008 and -34% in 1987, 2002 and 2020. 

If your beliefs or disbeliefs are dominant in either column, you are at risk of Conformity Bias and should examine the opposite point of view. This will enable you to set up an early warning signaling the pendulum is swinging in the opposite direction to your basic beliefs.

What to Do?

The most difficult job of a good portfolio manager is to periodically balance different points of view and quickly recognize early warning signs of a change. (At the track, a sudden shift in odds indicates new money has a different view, which should be re-examined to see if it contains new information which merits a change of opinion.) 

It is rare for our fiduciary portfolios to not have elements of growth and value. This is particularly true when the portfolio is broken down into sub-portfolios based on different payment and volatility needs. Currently, another major focus is domestic versus international, with China being under a controlled slowing and the US possibly being under a dangerous induced expansion.

Brief Updates 

Each of the following could be developed into its own blog, but I will spare you, although I’m happy to discuss these items with subscribers offline.

1. There are rumors of the administration thinking about instituting a tax on miles driven. Also, there is talk of an excess profits tax on those individuals and companies that appeared to have made money due to the pandemic and lockdowns.
2. Union membership has been cut in half since 1975, when it was 20% of the workforce, but it has risen a bit very recently.
3. The NASDAQ vs NYSE, which is the leader? In terms of year over year volume, NYSE -34.69% vs NASDAQ +30.50%. New lows in terms of the percentage of issues traded, NYSE 7.6% vs NASDAQ 11.9%. The relative absence of passive investors in the NASDAQ may be causing the difference.
4. The JOC-ECRI Industrial Price Index year over year is +83.7%. (Closer to home, Ruth mentioned that not only are food prices going up at the supermarket, but also paper products. It would be reasonable to assume packaging costs are increasing too. Paper, and energy for trucks, are part of the JOC index.)
5. The AAII bullish/bearish reading is 50.9%/20.6%
6. The largest free cash flow sector is Financials.
7. Large commodity speculators are increasing their short positions over their growing long positions in copper, crude oil, gold, live cattle, silver, T Bonds, wheat, and the Yen.
8. Small-Cap Value mutual funds are the leading diversified mutual fund peer group +20.46%. Mutual Funds should be important to other investors as 47.4% of US households own mutual funds.
9. James Mackintosh mentioned in the WSJ that the three stages of debt expansion are: speed, stimulus, and inflation, as evolved by Hyman Minsky.
10. The Congressional Budget Office (CBO) believes it would be too difficult to cut the existing budget to cover all the new administration’s planned expenditures.

Special Announcement to my fellow Analysts

Over the weekend the New York Times (NYT) published an article on the death of Bernadette Bartels Murphy. She was a former President of the New York Society of Security Analysts, as was I. Bernadette re-popularized chart reading and helped put the Market Technicians on their feet. When I talk with portfolio managers who have survived the cyclicality of the marketplace, they rarely couch their thinking about market analysis, as many benefitted from her efforts. We and the market have lost a major contributor to our progress.

 

PS

Early Asian trades are reacting to rumors of substantial forced margin account liquidations, probably from hedge funds. This could be a problem for the US Monday morning.

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

https://mikelipper.blogspot.com/2021/03/2-presidential-lessons-to-be.html

https://mikelipper.blogspot.com/2021/03/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/03/next-race-winner-weekly-blog-671.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

2 Presidential Lessons to be Learned/NASDAQ Clue - Weekly Blog # 673

 

Mike Lipper’s Monday Morning Musings

2 Presidential Lessons to be Learned/NASDAQ Clue

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

 

For Want of a Nail

For want of a nail the shoe was lost.

For want of a shoe the horse was lost.

For want of a horse the rider was lost.

For want of a rider the message was lost.

For want of a message the battle was lost.

For want of a battle the kingdom was lost.

And all for want of a horseshoe nail.

A similar proverb has been coming to us for many centuries, in many languages, showing the critical importance of micro elements on macro events. As a bottom-up analyst I have learned to build macro views from the micro, distinct from many top-down thinkers who believe a macro view is appropriate for investment decision making.

Learning from Past Presidential Mistakes 

Before the current administration attempts to dictate its top-down views it would be wise to review the consequences of prior Presidents’ actions, which had the opposite effect of their intensions and led to severe repercussions for the world, country, and investors. In two cases, the party affiliation of the president did not save him from important mistakes.

FDR

The current administration is described as the most “progressive” since FDR, whose effort to redeploy the population and redistribute their wealth, took a bad recession caused by unsound debt policies and turned it into a long Depression lasting to the needed World War II. (Note, depression is a psychological term and is not designed for an economic period.) The lesson coming from this 12-year period was the central government being as much a part of the problem as the solution. In the eyes of potential aggressors, the US was weakened and would be slow to respond due to a lack of demonstrated political will. (Including, shifting government spending from buying to producing, a weak and outdated military, raising taxes on productive portions of society, and making it illegal for Americans to own gold.)

Richard Nixon

Became an advocate for Keynesian contracyclical spending and closed “The Gold Window”, which prevented  the US from buying gold from foreign nations for dollars and ignited the sharpest rise in inflation in modern times. While he did open the door to China, he saw it in military terms and did not contemplate the commercial plusses and minuses. 

Influences on the Stock Market

There are three mega market concerns: 

1. Economic/political concerns
2. Corporate views and earnings
3. Market structure changes

I am delighted most investors view the market impact in the order listed. As a contrarian, I take the reverse order as more important. Looking for “The Nail…”. A basic rule of investigation is to not believe the owners of the “printing presses”, demonstrated by the Federal Reserve’s terrible record on predicting economic turning points. One of the reasons that their record is so bad is that the Fed and the government use tax data for individual income. (I am sure everyone reading this blog attempts to show the maximum amount of possible income on their tax forms.) 

Corporate earnings releases have become very “plastic”. “Adjusted” financials now take prominence over audited statements in letters from the CEO. In the era of ESG and Diversity, commentary is about wishes and intentions, not current conditions. Thus, I put much more credence in securities transaction reports, even though I am conscious of trades occurring “off the market”. In addition, for historical reasons I have a lot of confidence in mutual fund data. It is from these vantage points the following views are offered.

Current Briefs

1. In the current week ended Thursday, mutual funds gaining more than 10% for the week included: 5 Value funds, 4 each in small and mid-cap funds, and 2 each in Core Commodities and Global funds. While smaller and mid-cap value funds were generally favored, individual stock selection was critical.
2. Six of the top 25 for the week invested in Japan and 8 of the bottom-10 were invested in natural resources.
3. Net fund flows for the week focused on portfolio attributes as well as immediate performance.
4. The JOC-ECRI Industrial Price Index year-over-year is +75%

New York Stock Exchange vs. NASDAQ

1. Volume year-to-date through Friday:  NYSE -25.57% vs. NASDAQ +25.14%                                                                                                                           
2. New Highs, New Lows, Number of Securities Traded

                 NYSE     NASDAQ

New Highs    820        784

New Lows      95        231

# Traded    3419       4322

NYSE is more bullish, but NASDAQ is Savvier, as shown on Thursday with the 400 plus point drop.

What Do You Think? Did I find a nail? If not, what would be?

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

https://mikelipper.blogspot.com/2021/03/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/03/next-race-winner-weekly-blog-671.html

https://mikelipper.blogspot.com/2021/02/did-something-happen-last-week-weekly.html

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A. Michael Lipper, CFA

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Comfort Concerns - Weekly Blog # 672

 

Mike Lipper’s Monday Morning Musings

Comfort Concerns

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

Good Numbers

This week’s US stock market performance numbers are great: Dow Jones Industrial Average (DJIA) +4.07%, NASDAQ +3.09%, and S&P 500 +2.74%. (Cannot expect to keep up this rate.) Individual investors apparently believe these bullish results can continue for at least six months. The American Association of Individual Investor’s (AAII) weekly sample survey indicates that 49.4% are bullish, up from 40.3% the week before. (Market analysts treat the AAII numbers as a contrarian indicator.)

One of the underlying supports for this bullish attitude is the average per person wealth in the US surpassing its former peak, which occurred just prior to the Coronavirus hitting. This is true, according to the Federal Reserve, even excluding the net worth of the 2100 US billionaires, who produced an average per household net worth of $330,000. (In view of these numbers, one wonders if the various stimulus measures passed, and other discussed, are going to unleash high inflation, with too many dollars chasing too few dollar-earning assets.)

By far the largest portion of the average American’s wealth is invested in financial assets (equity and fixed income), followed by real estate. A sample survey of people expected to receive stimulus checks indicates they plan to put half of it into “the market”. This appears to be particularly true of younger or inexperienced investors.

Late Stages

Often, individual and institutional investors who’ve built up their cash reserves, as many currently have, get sucked back into the market. (There is the story of Sir Isaac Newton, the famous scientist and the Master of the English Mint, who withdrew his personal assets from the market in the early stages of “The South Sea Bubble”, only to be sucked back in during the momentum move at the end, losing all his money.) Investors, recognizing the declining value of their money relative to the sharply rising value of tradable assets, often feel the need to quickly catch up and concentrate their purchases on what is moving up the fastest (momentum). 

Interpreting Fund Flows and Yield Curves

The combination of flows into both conventional mutual funds and exchange traded funds (ETFs) has been positive the past few weeks. This represents a change for mutual funds, particularly equity funds, which for many years have been in net redemptions, despite generally good absolute investment performance due to actuarial and job-related issues. 

Investors reaching retirement age often reduce their perceived risks by reducing their equity exposure. Sometimes, this switch comes earlier than expected due to an earlier than planned retirement or a business difficulties. Exchange traded fund products often attract shorter-term investors, who want to capture market volatility and some tax advantages.

The recent change in the aggregate behavior of fund buyers suggests, similar to The South Sea Bubble, that normally conservative investors feel their reserves are losing value relative to equities. This past week, investors put a net $45 billion into funds, with $29 billion going into money market funds and only $15 billion into equity funds. $1.1 billion went into tax exempt funds and $683 million went into taxable bond funds. I suspect a good bit of the money going into money market funds was transitioned from other investments.

The US Treasury yield curve tracks the difference in yield at various maturities. Interest payments are made to investors for delaying the consumption of their wealth, or for investing in more active and speculative securities. It makes sense that the longer investors delay spending their money, the more they should demand from borrowers,  often the US government. Investors traditionally need to guess how much purchasing power will be lost over the period they lend their money out. When they demand higher interest rates, particularly for extended periods, they are gauging their inflation risk. 

Today, there is a major dichotomy between what the US Government thinks long-term inflation will be, through the Fed and Treasury, and what the commercial world thinks. The US Government thinks it’s under 2%, while the JOC-ECRI Industrial Price Index year over year change is now +59.48%! Even if one discounts the index by 90% due to its volatile composition, this suggests future investors dealing with inflation rates in the region of 5%. This 2-5% spread is enough for some investors to change their asset allocations.

In searching for investments to protect against the markets being flooded with cash and materially higher inflation; it is normal to look for an investment with momentum behind it. In many ways momentum is a catch-up move to compensate for prior slow or down periods. Thus, it is not surprising that 16 of the best performing mutual funds for the week were small-cap funds, with the others tied to rising energy prices or financials expected to be flush with earnings from reserves that are too high. 

Warning!!

Four of the worst performing funds for the week were invested in the China Region. This is disturbing, as China is the single largest contributor to both global growth and world trade. The authoritarian government is actively attempting to address a growing debt expansion. While the debt is on the books of various provinces and non-bank financials, it is both a political and economic problem for the central government due to the exposure of the Chinese people. A slower growing China could be a major concern for the rest of the world.

Conclusion:

Each investor should review the concerns raised in this blog and make their own decision as to how to apply these possibilities to their multiple investment responsibilities. Please don’t ignore these possibilities completely. 

Also, if you would like to discuss, I would be happy to have a Socratic discussion with you. 

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

https://mikelipper.blogspot.com/2021/03/next-race-winner-weekly-blog-671.html

https://mikelipper.blogspot.com/2021/02/did-something-happen-last-week-weekly.html

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

Did someone forward you this blog? 

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Next Race Winner - Weekly Blog # 671

 

Mike Lipper’s Monday Morning Musings

Next Race Winner

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

My best education in picking my next winning investment was not taking the graduate course in Security Analysis as an undergraduate under Professor David Dodd, co-author with Benjamin Graham of the seminal textbook. While the course was very valuable in helping me understand markets, it was not particularly useful in helping me pick future winners, particularly if the future was different than the past.

My single best education in picking winning investments were from the grandstands and paddock at the New York Racetracks. Losing some of your hard earnings on foolish bets did wonders for concentrating the mind. The purpose of this blog is not to discuss handicapping horseraces, but to share an approach for avoiding losses and making betting profits overall.

For purposes of this blog, there are three analytical elements from the track I find useful in picking investments. These elements also help in limiting losses and produce winners over time. (Hopefully, some of my grandchildren and great-grandchildren will learn these approaches as they invest time, money, and emotion in their lives.)

While both security analysis and racetrack handicapping delve into history going back three generations or more, handicapping is more focused on future races or tomorrow’s newspapers than the extrapolation of current trends. One handicapper advantage is the identified conditions of the race are stipulated. How tomorrow’s headlines will impact tomorrow’s investments is unknown. The first analytical task at the track is to compare the conditions, including: distance, weather, track conditions, weight carried on the horse, the jockey, and equipment on the horse. These items, among other things, should be evaluated for all the horse’s recent races and for the upcoming races. (I only wish I had the same level of detail in making marketable invest decisions.) 

In studying the past races of horses, it is worth noting how the horse reacted under past conditions and what the anticipated changes are in upcoming race. Some horses, if they get to the front early on a muddy track, can hold on and win if they are not too tired. Others, that have a lineage or history of regularly coming from behind, particularly on a muddy track, can beat tiring horses. (Some CEOs have no experience being raided or losing a crucial patent case, while others have campaigned successfully in these contests.)

Speaking of the difference in CEOs. Some jockeys use their whip frequently and punish horses not running to their capacity, whereas others ride with a light touch and coax the best out their horses. While one might like one type of jockey over another, the horse owner and future breeder, or the trainer, is probably a better judge. (The Board of Apple fired Steve Jobs who was not doing a good job, but then rehired him after he got more experience at managing a company. They later replaced Jobs, who was ill, with a much different Tim Cook. I have made a lot of money investing in companies that had CEOs I would not want being the trustee of my children or on a desert island, although they did a great job running the company.)

Currently, one of the most useful techniques is to look for horses not moving the fastest in the previous part of the race. Although not winning the previous part of the race, they were passing tiring horses or were accelerating. They did this because it’s the way they run in the early part of a race, or because they didn’t have sufficient racing room. In science & tech, biotech, and entertainment companies, the future is dictated by what is in development, not past financial records.

Applying Track Lessons to Current Investment Policy

For the next generation, the investment world is likely to be dominated by China and the US. In future generations, India, Indonesia, and Nigeria could become fully competitive. Today, a dollar-based score card would have the US far in the lead, probably making it the single biggest component in a long-term investment account. However, China is the fastest moving economy. We may not like the way their jockey rides his horse (Nation), but he has been very effective. He has also recognized the provincial debt problem, which has political implications and needs to be watched. 

There is no reason to doubt China will exceed the US in many ways in the foreseeable future. The actual timing of their taking the lead is a function of the additional weight we are putting in the US saddlebags to slow us down. Thus, any investment should be analyzed with an eye toward what China is doing both at home and globally. Hedging large US investments may require some investment in Chinese enterprises.

A Slowing/Maturing US and Redistribution

On a secular basis, US operating margins have been slipping for some time. We have not noticed it in reported earnings per share due to a combination of issues, camouflaged by increased debt, lower taxes, more foreign earnings, and buy-backs. We have become a mature economy with a small working age population. Furthermore, our school systems are producing people with insufficient real-world education and poor work attitudes.

 

In many ways the current administration is repeating the errors of the 1930s, where the government took a somewhat normal recession caused by excessive leverage and turned it into a depression by attempting to use authoritative top-down social mandates. They terrorized private capital, leading to a slump in capital investment and the formation of new companies. 

As is often the case, one should not pay heed to what professional politicians say, but to the impact of what they do. The “COVID $1.9 Trillion Bill” rammed through the Senate should be relabeled “The 9% COVID Solution to Political Problems Bill”, “The First Redistribution Act”, or “The How to Kill Your Children’s Opportunity Bill”.  

The real intent of the Administration is to increase the deficit in any way it can, requiring taxes to be raised through one large omnibus bill or many separate acts. Their main purpose is to capture private-sector money and use it to fulfill socialist goals. What they forget is that close to half of all employees work for small companies, which large companies depend on to train their future workers. These small companies also produce products and services at lower cost, in part due to their lower compensation and benefits.

The initial capital supporting a small business is the after-tax savings of the entrepreneur. Support also comes from the after-tax savings of family and friends. The more successful small businesses can occasionally tap into private equity and debt funds, which are also funded with after-tax dollars. The pool of after-tax savings comes from the net profits after inflation, and the declining value of the US dollar will curtail the purchasing power of domestic earnings.

Looking to the future of our grandchildren and great grandchildren. They should be prepared to live outside of the US, possibly in Asia, as the reduction of private capital will reduce job opportunities in the US. Sound retirement planning suggests that US investments should be hedged by appropriate investments beyond the control of the US government.

There is Some Hope

Both the current occupant of The White House and his predecessor are doing a brilliant job adding to the base of their rivals. As both leaders pull more away from the center, some will want protection against the extremes. The 2022 congressional elections are an opportunity to accomplish a strong center by electing centrist Senate and House members of both parties. This could prevent The White House from accomplishing its redeployment of capital and other socialist goals. 

It could happen. The current topping of the US stock market and collapsing US Treasury prices, along with the declining value of the US dollar, should be enough of a warning. If not, we could see a copy of the long depression, leading eventually to an economically provoked war.

Questions of the Week:

1. Do you think this kind of problem set is possible?
2. Do you have any plans to include this possibility in your investment planning?

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

https://mikelipper.blogspot.com/2021/02/did-something-happen-last-week-weekly.html

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

https://mikelipper.blogspot.com/2021/02/mike-lippers-monday-morning-musings.html

Did someone forward you this blog? 

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A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

Did Something Happen Last Week? - Weekly Blog # 670

 

Mike Lipper’s Monday Morning Musings

Did Something Happen Last Week?

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

Great Discomfort, Almost Panic, Large Growth Funds, Long Treasuries

Market participants apparently reacted to the further steepening of the US Treasury yield curve, with higher interest rates for longer maturities. (This was not a surprise to me, I have been focusing on higher inflation for a while. This week the JOC-ECRI Industrial Price Index reported a +47.91% rise from over a year over year. Also, my wife noted that supermarket prices are rising.) 

The impact on large “growth” stocks, as measured by large-cap growth mutual funds, declined by mid-single digits for the week. The connection between rising long-term Treasury yields and stock prices for companies with large amounts of cash and relatively low debt, surprised much of the public and some in the media. In theory, growth stocks are valued at what the market believes are their future stock prices, discounted by the cost of money until they are sold. The lowest discount rate used is the yield on long-dated treasuries. Thus, the reaction to the steepening of the Treasury yield curve makes growth stocks less valuable. Approximately ten of these stocks have been the engines of superior price appreciation in large institutionally managed portfolios.

Investors do not reveal the motivation driving their decisions and commentators consequently we use circumstantial evidence to ascribe motivation. As a skeptic, I look for other non-publicized explanations. 

Questioning the Gospel

The new administration has been fortified by the naming of the Treasury Secretary, a former chair of the Federal Reserve and former labor economist. For more than a year the previous administration believed in the long-term continuation of low interest rates. This belief comes from their indoctrination into Keynesian economics and has become the accepted dictum for governments since President Nixon announced, “We are all Keynesian, now”. Without any constitutional or legal authority, the function of government has now been determined to be the management of the economy to produce full employment. 

In John Maynard Keynes’ “General Theory of Employment, Interest and Money” published in 1936, he laid out the principle of the government (the people) funding contra-cyclical spending, providing money to hire out of work people through deficits or higher taxes.

Apart from the recent Trump tax-cuts, I don’t believe there have ever been tax cuts, other than as a “peace dividend” after a military war. Part of Keynesian policy was to set interest rates low during a recession and raise them in good times. To no one’s surprise there has never been an example of deficit reduction in good times. 

Keynes’ policies resulted in lenders being unable to make up for losses from defaults or late payments, which were critical in restoring the capital of lending institutions. That Keynes came up with this scheme in the mid-1930s is not surprising. In the US and around the world there was a movement toward more authoritarian government. Is it possible that this week’s “taper tantrum” was some glimmer of thought that governments might be responsible for the level of employment through low interest rates under Keynesian economic principles? Only time will tell, but very surprisingly it could happen now or in the immediate future.

What the Market Says?

The first two months of 2021 is now in the record books. The five leading mutual fund peer groups through Thursday night were:

   Natural Resource Funds         +26.38%

   Energy Commodity Funds         +24.80%

   Base Metals Commodity Funds    +18.36%

   Global Natural Resource Funds  +16.37%

   Small-Cap Value Funds          +15.83 %

Clearly, we are seeing energy and base metal prices rising, although some believe it’s not the result of short-term shortages. What is perhaps most interesting are the gains of the small-cap value funds. For years, small caps underperformed larger caps and “value” underperformed “growth”. On a year to-date basis the average small-cap fund has gained more than the average mid-cap fund, which in turn was up more than the average large-cap fund.

This change in performance leadership is broad and meaningful. The NASDAQ composite is leading the Dow Jones Industrial Average (DJIA) and the S&P 500 in both directions. I believe the reason for this is that most large index funds and closet indexed portfolios focus on NYSE listed stocks in the two senior indices. The more volatile NASDAQ attracts a higher percentage of traders and has a greater number of would-be growth companies.

The price chart for the NASDAQ is completing a “head and shoulders” reversal pattern, with the price pattern of the other indices not far behind. Valuations are high for the S&P 500, which has a price/earnings ratio of 21.5x, compared to 15.8x ten years ago. Also, because of both lockdowns and cash from the government, savings are 20.5% of after-tax income.

Investment Conclusion:

We may be near to both a short-term top and possibly a major revision in the long-term thinking of investors. 

Share your views, please.

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

https://mikelipper.blogspot.com/2021/02/debt-inflation-and-markets-weekly-blog.html

https://mikelipper.blogspot.com/2021/02/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/02/adjust-investment-tools-for-next-phase.html

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Copyright © 2008 - 2020

A. Michael Lipper, CFA

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Debt, Inflation, and Markets - Weekly Blog # 669

 

Mike Lipper’s Monday Morning Musings

Debt, Inflation, and Markets

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

I. The Changing Value and Price of Money

As is often the case, when we speak of purchasing a good or service, we mention its cost in our local currency. We don’t view the purchase in terms of unrelated transactions, like a vacation vs. a month’s rent. If we were more intellectually rigorous, we would calibrate the purchase in terms of inflation and currency exchange rates. For those whose wealth is totally used up by spending, this thinking is understandable. However, for those who have savings/investments, this singular way of thinking reduces future wealth and spending power.

With the above predicate, all savers/investors should focus on prices and inflation. An agreed price is the result of supply meeting demand and the costs incurred in the present or future. As in a gunfight, don’t show up with only a knife. For serious purchases, don’t bargain without insight into the history of prices. In the modern world, where services are the largest part of an economy, we have difficulty grasping the costs driving prices. For manufactured goods, the costs of raw materials and industrial goods play a dominate role, excluding the cost of labor. That is why I pay attention to the weekly reading of JOC-ECRI Industrial Price Index, which saw a price rise of +44.83% year over year. Part of the price explosion is due to capital expenditures not keeping up with demand. For example, Goldman Sachs is warning of a copper scarcity in the coming months, leading to the largest deficit in ten years. A somewhat similar situation is occurring in the oil patch.

In analyzing inflation, it is useful to recognize who benefits, who hedges and who loses. The pure benefactors of rising inflation are the relatively few that gain from rising prices, due to it being the sole input to their financial well-being. Most people have a mix of prices received and prices paid. Some are naturally balanced, while others hedge offsets. Non-savers/investors who consume all their income are clear losers, as the losses created by the declining value of a currency are the equivalent of a tax. 

The motivations of the Federal government are mixed. When governments pay off their debts with inflated dollars, they net the difference between the purchasing power of the dollar and its contractual payment value. In addition, personal income tax payments rise on the inflated income. (Since corporations pay taxes on their pretax income, which may be offset by inflated costs, their pain of inflation is less.) 

From a political vantage point, the financial problems of the non-saving poor are intensified. However, for some politicians this problem has a “silver” lining, it encourages the redistribution of wealth through the socialization of the concern. In a healthy economy, increases in productivity often create gains that offset the pain of inflation, but US redistribution also leads to increases in jobs overseas and makes international investing more attractive. (The difference between international and global investing is that international investing excludes the home country, which global does not.)

Most investors ignore declines in purchasing power due to currency depreciation or inflation, if they are small. Due to current conditions and global political leadership, it may be prudent to adjust investments.

II. Breaking the “Bubble” Ahead?

Since the beginning of recorded history we have dealt with seasonal cycles and those that last longer. Trading markets adjust due to the relative strength of buyers and sellers, thus markets have they own cycles. Economic and market cycles do not always coincide, and when they don’t coincide the amplitude of the cycles is more limited. As long-term investors, we therefore need to examine the probability of the next declining phase, both in terms of economic and market cycles. In analyzing cycles it is useful to look at elements the popular media and marketers can spout quickly. You should also look for structural changes that can cause the foundation of the cycle to weaken to a point where it collapses. What are the signs I see?    

Economic Structural Issues

Debt is a major accelerator of most economic collapses, distinct from those primarily caused by political, medical, or climate changes. Debt is already growing much faster than the economy, even before the full increase in debt at all levels of government globally is disclosed.  Normally, the banking system controls the policing of debt. However, significant debt is being extended by non-bank credit groups in many countries, including China and the US. The problem with debt is that it replaces equity for temporary uses and speculative purposes, solving short-term needs, but doing little to generate long-term investment. While China and some other countries are spending on infrastructure to produce longer-term economic gains, it is not happening in the US. While both the past and current administration have discussed infrastructure programs, the private sector has not indicated a willingness to provide substantial equity. We don’t seem willing to get little or no cash return for a number of years, before the supposed gusher of profits arrive.

The steepening of the yield curve may be capturing this reluctance. There is great competition to supply short-term funds for margin debt and short-sales by brokerage firms and banks. Bank money market account interest rates dropped below 10 basis points this week, indicating banks have no need to attract new deposits to make additional loans, driving the front end of the yield curve even lower. On the other hand, interest rates at the long end of the curve are now higher than they were last year. One should remember that the published yield curve is for US Treasury paper and long rates for perceived lesser credit should be higher. This drives up the costs of long-term equity dollars, making them scarcer.

This week’s weather in Texas and the Midwest shows the need for much more capital spending on local infrastructure and power generation. The purported growth of electric vehicles will also shift energy needs from oil to natural gas, which should economically be distributed through pipelines, contrary to the present government’s wishes. The combination of new regulation and higher taxes means that many energy facilities will be taken off-line. Fitch believes the removal of these units for economic production will reduce the earnings of the energy companies, which in turn will lead to lower credit ratings that drive up their capital costs. Beyond the energy sector, the expected jump in taxes and regulation will reduce the ability of industry and individuals to generate capital for spending and investment.

Stock Market Structural Changes

Most of the time money follows performance. In the week ended Thursday, an index of the large S&P 500 index funds gained +4.47%. Five other equity fund indices were up at least twice as much:

  Lipper Small Cap Value           +13.13%

  Lipper Pacific Ex Japan          +13.10%

  Lipper Global Natural Resources  +11.66%

  Lipper Science & Tech            +11.48%

  Lipper Financial Services        +10.05%

There is no common denominator in the five leading groups, except they are not primarily large companies and the leading tech companies have less influence of in the portfolios of the largest funds.

The cash positions of many of the leading institutional investors are near a historic lows and the new speculators are heavy users of margin. The American Association of Individual Investors (AAII) weekly sample survey of bearish sentiment for the next six months has dropped 10.2% (25.4% vs 35.6%) in the last three weeks, with an almost concomitant rise in bullish sentiment (47.1% vs 37.4%). Professional market analysts view these as contrarian indicators and the combination of the three sentiment indicators could be significant.

Investment Conclusion

Rising stock markets have a habit of lasting longer than when structural problems are present, staying “bullish” until something changes mass opinion. I would use this enthusiasm to raise this year’s cash needs. I expect within two years we will have an opportunity to buy valuable investments with more knowledge and at better prices.

   

Important Note: 

I always want to hear from our subscribers, but I particularly appreciate hearing from subscribers that can correct or disagree with what I have written. That is how I learn to do a better job. In response to last week’s blog, a long-time subscriber and investment professional with non-Us experience, correctly noted that the Declaration of War between Germany and the US was declared by Germany a few days after the December 7th attack on Pearl Harbor. It was followed  by the US declaring war on Germany in a reciprocal move. This re-enforces my view that the main impact of an action is often the reactions of others to the event. In this case, if the move by the Germans was to support Japan, it had a different impact on both, as well as the US. In terms of Germany and the US, it led to a two-front war waged by the US, with the political decision to primarily focus on the European War. This in turn gave more force to the industrial mobilization of the US, which probably shortened the overall war effort,  leading to the surrender of both Japan and Germany. One should think through the reactions of others to the moves you make.

Question of the Week: What is the worst for which you are prepared? 

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

https://mikelipper.blogspot.com/2021/02/mike-lippers-monday-morning-musings.html

https://mikelipper.blogspot.com/2021/02/adjust-investment-tools-for-next-phase.html

https://mikelipper.blogspot.com/2021/01/is-gamestop-missing-event-weekly-blog.html

Did someone forward you this blog? 

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

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.

This Week’s Implications for Our Investment Future - Weekly Blog # 668

 

Mike Lipper’s Monday Morning Musings

This Week’s Implications for Our Investment Future

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

Late-Stage Markey Surges

Through Thursday, the average US Diversified Equity Fund rose +2.49%. While not followed closely beyond the mutual fund business, it should be. The total assets of these diversified funds at the end of January were $ 10.7 trillion, compared to $16.2 trillion in all equity funds. These are the aggregate investment decisions of the largest group of individuals and institutions, distinct from measures developed by publishers.

Each week I look at the performance of 18 different types of diversified equity funds, which excludes more narrowly based specialty funds. Two observations of this week’s performance are:

1. This week’s performance is unsustainable. If annualized, the performance would be almost 260% for the year. 
2. Within the largest macro fund category, S&P 500 Index Funds gained +1.20% and ranked 17th out of 18.

These observations are like what I have seen or read about in the late stages of a “bull” market. In most markets, the performance for S&P 500 Index funds rank in the middle to top of their macro group. The reason for this is that they are low turnover portfolios, with no cash holding them back in rising markets.

Late-Stage Leaders

If the +2.49% gains for US Diversified Equity Funds is unsustainable, then look at the other four leading investment averages:

    China Region           +5.29%

    Equity Leverage        +5.10%

    Global Science & Tech  +4.22%

    Small Cap Growth       +4.04%

(Remember, these numbers are averages, several funds had substantially greater than average gains.)

Other Late-Stage Observations

• Contrarian indicators include an 8% increase in bullish sentiment for the American Association of Individual Investors (AAII) weekly survey, which now stands at 45.5%.
• 81% of Wall Street Journal prices rose this week. 
• Both the New York Stock Exchange (NYSE) and NASDAQ reported a 6% drop in short sales. (The reason a drop in short sales is viewed as a negative is that short sales need to be closed by a purchase, which adds to volume.)
• Market analysts become nervous or at least suspicious when formerly visible trades are hidden. 47.2% of equity trading-volume was not on the publicly traded stock exchanges. While this may lead to some investors getting better prices, it raises questions as to the validity of reported prices. This is not reassuring in highly speculative, volatile markets.

Possible Investment Implications Learned from the Impeachment Hearings with a look at History.

As much as possible, the following observations are intended to help make the investment decisions that will impact future investment performance. Words spoken by elected and unelected politicians are like hourly or daily temperature readings, good for conversations but not to be taken seriously when setting and executing long term investment policies. Actions have longer-term implications for historical purposes and provide some factual inputs in understanding what happened. Far more important are the reactions to actions, usually not by the original actor. 

The following is a historical example of this principle. The Imperial Government of Japan attacked the US naval and airfield installations in Pearl Harbor on December 7th, 1941.  The attack was timed with similar attacks in Asia to establish a “Co-Prosperity” Asian region, with Japan as its supreme leader. The attack on the US was designed to prevent a well-armed US from coming to the aid of the Asian countries being invaded. They were successful in destroying our aging battleships. (For the only time in recorded history, the US aircraft carriers were out at sea alone.) This was the deed, but the key to the future was the reaction. 

FDR used the attack to declare war on Japan, as was expected. But in addition, he declared war on Germany and the axis allies, which was not expected. (FDR did not want to be considered a President Wilson, who entered WWI two years late and changed the history of Europe, Russia, and WWII. He was conscious that his cousin, Theodore Roosevelt, had won a Nobel Peace Prize for settling the war between Imperial Russia and Japan. Later, he split the presidential vote in the US, which elected Woodrow Wilson as a minority President.) FDR resisted entering the War with Germany for two years, as it would have been unpopular in the US and would have added to the problems of his mismanagement of the economy, which resulted in the longest and deepest depression in US history.

What the Japanese did not count on, was the attack on Pearl Harbor and the saving of our aircraft carriers giving FDR’s the political power to galvanize the US. It enabled him to fight both a World War and push through various social moves which had not been possible beforehand. Regardless of how one feels abut my narrative, there is no question that the reaction to the attack on Pearl Harbor was much different than the Japanese had intended.

Could We Be in a Similar Position Now?

Some have suggested that the new administration is the most politically left leaning group since FDR. The staffing of the Cabinet and administrative functions with former Obama people is like FDR’s brain trust. To see the ambition of the current leadership, read the proposed Antitrust Merger Standards, which would allow the government to decide on all future mergers. (This is a backdoor way to establish an “industrial policy”, which numerous countries have thankfully tried, removing a lot of vital competition in the global market. Another example of the ambition of some in Washington can be seen in the “reconciliation budget” proposal from the Financial Services Committee in The House. It has a current spending plan of $38 Billion and would reach $72.9 Billion by 2031. (I would like to learn how much our taxes will have to rise for this relatively small desire of the party.)

The President Could Be Saved from Himself

Just as reactions to an action can be contrary to the expressed wishes of the actor, so too can the current actions of the President and The Speaker of the House. We are seeing them both play to their own majorities, but they are driving away more of the middle in the process. Considering both of their elections had smaller pluralities than expected, the House Leader is now the only person in her role to lose two impeachments, which could have been won if better managed. The President appears to be creating more unemployment, more businesses closings, and a reduction in the level of education at all levels. We will have to see if any foreign government does anything meaningful we want.

If Not, is a Long Recovery a Prospect?

Without meaningful political changes, an FDR length depression could occur. Right now, I believe most worried investors are still treating the current phase as a cyclical depression that should be complete within four years. That is what I am doing, but it could be a lot longer and I am not prepared for that.

Question of the Week: What is the worst for which you are prepared? 

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

https://mikelipper.blogspot.com/2021/02/adjust-investment-tools-for-next-phase.html

https://mikelipper.blogspot.com/2021/01/is-gamestop-missing-event-weekly-blog.html

https://mikelipper.blogspot.com/2021/01/are-we-strolling-promenade-deck-of.html

Did someone forward you this blog? 

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

Copyright © 2008 - 2020

A. Michael Lipper, CFA

All rights reserved.

Contact author for limited redistribution permission.