Sunday, December 4, 2016

University of Investing Through a TIMESPAN Lens

“Today, if there is a run out of US Treasuries because of the Volcker Rule and Dodd-Frank,
 there is not enough liquidity at current prices.”


I feel that each day is the first day of attending a very learned university. In my case it is a University of Investing. I search each item that crosses my screens, my desk, or interactions with others for possible meaning for my clients or my family's investments. Every day there is so much to learn that without some attempt to organize the inputs one can get overwhelmed. Thus I am suggesting that the inputs be organized into class structures as if one progressed from basics to advance courses. After the confusions from the recent elections, including (as I compose this blog) the Italian referendum allow me to demonstrate how I place inputs into a somewhat organized structure.

Freshman Level

It is at this level one learns basic principles that one applies throughout life. One could do far worse than to have as your initial investment professor Jason Zweig, the erudite columnist for The Wall Street Journal. There is wisdom in his opening sentence to this week's column on the attractiveness of small-caps. He wrote, "When markets go way up, your enthusiasm should go down." This wise cautionary statement should be applied to all asset classes and individual investments. Applying this to various popular leaders also may be wise. Remember in both the sports arena and the political world the crowd’s purpose is to build up a person or an idea to an untenable height to then have the pleasure of watching them fall. Coming out this class one should believe in moderation. One needs to be prepared for some failures along the way, which does not signify that in the long-run our hero or heroic idea will not work out.

No freshman year should be complete without some field work. It is important to identify what other people think. More importantly it is critical to learn whether opinion leaders should be believed. Thus, the next course might be devoted to the various Pew surveys, in this case reported on by Kopin Tan of Barron's. When asked in terms of trust, the respondents indicated their level of trust was 33% in the military, 24% in medical scientists, 5% in media, 4% in business leaders and 3% in politicians. As a US Marine now in civilian clothes and a senior trustee at Caltech, I believe in the ranking order if not the numerical results. I wonder where the average academic would place? The investment lesson drawn from this survey is to focus on what people actually do and what they can do by themselves.

Sophomore Year

This is often the period of students knowing it all because they believe that they have decoded the world and know what is actually happening. They have learned that this has been a difficult performance year, particularly beyond the popular mechanical averages. What they may not appreciate is that there were many ways to produce above average returns. There were eight separate mutual fund investment indices that produced double digit returns as of Friday. The lead was Small Cap Value +22.82% which was followed by a number of other small, mid caps, and multi-caps both value and core. More interesting to me that in addition to these, both Large-Cap value and Equity Income made the double digit list. This suggests to me that while being in the favored asset class helps, individual security selection was also important. A somewhat similar conclusion can be derived from examining the ten best performing fixed income fund categories. In the year to date period when the average general US Treasury fund had a 0.61% return, there were ten taxable fixed income objectives that gained between 4.26% and 11.34%. The top five were:

Fixed Income Objective
Year-to-Date Performance
1.  High Yield funds
2.  Emerging Market Debt Hard currency
+  8.78%
3.  Loan Participation
+  7.96%
4.  Multi Sector
+  6.17%
5.  Emerging Market Debt Local Currency
+  6.08%

To show the trading mindset one can look at this week's flows into specific Exchange Traded Funds (ETFs). The second largest inflows were to First Trust Industrial/Producers Durable + $740 million and the largest redeemer First Trust Consumers Staples -$707 million. This suggests that main players in  ETFs are trading not investment organizations and as they grow and narrow their focus they can be a disruptive influence on some stocks some of the time.

Combining the first two sophomore class lessons, one of the best technical market analysts is close to calling the end of the thirty five year bull market in US Treasuries. As essentially an equity investor, I am worried of a repeat of what happened to emerging markets debt and equity when Russia defaulted on their own Treasuries. While this was a specific isolated problem, trading desks that owned them found that they were substantially below minimum capital requirements and sold whatever they could to get back into capital compliance. Today if there is a run out of US Treasuries because of the Volcker Rule and Dodd-Frank, there is not enough liquidity at current prices. Thus various banks, brokerage firms, and leveraged hedge funds will sell what they can to meet capital needs which means they could be massive sellers of equities. This condition may never come to be, but a rumor of it could cause almost the same level of damage. For the moment in one part of the fixed income market there is some lessening of risk. Moody's* has reduced its estimates of high yield default risk.
*Owned personally or by the financial services fund I manage.

Upper Classmen and Women

Once the students get closer to graduation from their protected environment they should be focusing on jobs both in general and specific for them. The pre-lawyers and pre-politicians in the class will be quickly disappointed to find in various constitutions that there is no requirements to create jobs or preserve them from economic realities. For some time students and their academic advisors believed that this was the function of the reigning government and if not this one, the next one. In a global world the reality is that government using its tax power on present and future generations does not have direct ammunition to create all the desired jobs. As my fellow Caltech Trustee and neighbor pointed out to me in a well reasoned reaction to last week's blog, (copies available for the asking), that the US has been shedding manufacturing jobs since the 1950s and Western Europe, Latin America, and Japan are following. It is his guess that China has or will soon enter this phase.

There is a growing need for employees in the service sectors. The problem that I see is that these openings are not being currently filled. The cover story is that the applicants don't have the requisite skills. My experience as an employer is that too many of the applicants don't have the right attitudes of providing honest service to customers, fellow employees, supervisors, and owners. Far too many don't know how to budget their time, money, and efforts. They don't show respect to others that is the foundation of a successful service operation. Today we all are competing with international competitors and we need to respect them as well. I suspect that today's students will need to adjust their working life plans. In southern Europe the current official working life is 33 years, in Northern Europe it is 38 years. I have been working for sixty years and expect we should prepare today's students to plan to work in service industries for forty-five to fifty years.

Senior and Graduate Studies

Often one of the parlor games after a sports or political team loses is a post mortem as to where to assign blame. I remember a lot of books and words generated as to how we "lost" China. The plain truth is we never really understood China and never did own it.  As investors we need to come to grips on why China is gaining more power. It actually starts for us in an elementary school practice no longer being followed. In school every month we had to contribute savings from our allowance to a local savings bank account. We were being taught savings. This is not done today. As a matter of fact, one of the critical differences between us and Asians is their aggregate savings is about on-third of their GDP. In the US and Europe it is closer to one-fifth. Play out the benefits of faster capital growth and a materially-oriented younger population.

This is one of the reasons that I believe that the results both for good and less so will pivot on the events in China and the rest of Asia. From an investment standpoint we need to hedge our own success with some attention to them.

On a longer term basis after we get over the focus on job creation and preservation, when are we going to see organizations that will gain political prominence because they represent consumers and possibly another group representing savers?

After Graduation

Through these four phases of investing education you can see the logic behind our approach to TIMESHARE L Portfolios®

Sunday Night’s Headline

 Euro falls sharply against the dollar after Italian Prime Minister Matteo Renzi suffers a heavy defeat in Sunday's referendum.” There is a need to study more in terms of implications for near-term investing in Europe.  This could well be similar to the immediate Brexit decline and snap-back.

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Sunday, November 27, 2016

Short & Long Term Gifts to Investors


Traditionally in many societies there is a festival to give thanks for the harvest. At this Thanksgiving I find a lot to be thankful about as an investor and portfolio manager. While I personally have a lot to be thankful for, I am going to focus on the gifts that we can share with all investors. As regular readers have learned, I tend to look for investment clues to various future timespans. My comments will be arranged with the most current inputs first extending out to longer timespans.

The Richest Market

At the moment the US has the richest and most profitable market in the world for most goods and services, which means we can benefit not only from what we produce, but also what was produced elsewhere at relatively reasonable competitive prices. Thus, the celebration of "Black Friday," a market shopping holiday, but not an official government holiday, is an important event to be observed, literally. Each year my wife Ruth and I visit The Mall at Short Hills, one of the glitziest malls in the US. For many years we have visited there either on the official Black Friday or the next day if we think we can find a parking place. The following is a brief report on our visit that a number of our long-term readers expect.

We could quickly authenticate the belief that shopping online would seriously eat into the shopping at stores. While considerably more crowded than normal, we were able to find a parking space in six minutes versus under a minute normally. As trained people watchers, we quickly noted that there were more people than shopping bags greeting us in the mall. For the most part shoppers came in pairs or larger groups with one an active shopper and the other either an approver or a payer.  While there were a number of men in the mall the prime shoppers appeared to be women, often in groups that were intergenerational - from pushers of strollers to some using canes along with posses of high school and college age young women. A number of these wore full makeup and were dressed as "fashionistas." The younger women crowded into Aritzia, a shop that my Granddaughter works for as a "style advisor." From an investor’s perspective these purchasers were showing signs of optimism as they are getting ready for a better near-term future. (I don't know whether they have been infected by the Trump Stock Market or this was just youthful exuberance.)  Macy's reported that their website had to shutdown three times during the day due to volume of visits.

We saw no signs of major door breakers of very large discounts, even though we did see signs of 30-50% discounts. With the exception of Apple* cell phones we were not aware of any “must have” products that people, particularly men, must have. The Apple store was extremely crowded but not outside lines. It was well staffed and apparently productive. The Verizon store was less busy but a good crowd. The AT&T store had very few customers in a large store.
* I own shares in Apple.

From an intermediate term investor standpoint, I am wondering whether we should be looking at cell phones as a product or as an entry point to services revenues? In many ways one uses the device to deal with the service sector. (For those who are interested I would be happy to discuss my view that Apple is eventually a service company.)  There may be a much more important clue here.

In reviewing economic statistics from many developed countries, service revenues and the number of employees are growing faster than those involved with manufacturing. I wonder whether we have entered a post manufacturing world, where manufacturing's function is to produce entry points to services; e.g., cars will be needed for Uber drivers and users not for personal ownership. If this is half right, the political implications are mammoth. The out of work workers and miners may not get their old jobs back regardless of long-term trade deals, unless we enter into large scale military wars. In the absence of manufacturing and mining jobs; infrastructure, education, and healthcare will need qualified labor. This will be difficult but not impossible to achieve. (If domestic labor does not fill these needs, immigrants will.) A lot will depend on the individual, some will see themselves as individually empowered and will create their own opportunities. Others will hope that as a group there will be a solution to their problems and may be disappointed.

Other Thanksgiving Gifts

The next thing most likely will be seen as a threat, but I view as a potential opportunity. We have been indoctrinated to believe China has replaced Japan as the second largest economy. On a purchasing power basis it is actually bigger than the US. In many ways this is a plus. The US is no longer the main growth engine for the world. Even though it is being guarded as a fortress, the potential Chinese market is large and under-served. The challenge for the new US Administration in the long run is not protecting our domestic market but opening up the Chinese domestic market as it grows. This will not be easy as both of us will be facing financial problems over the next four or five years. The odds favor that we will have our own economic recession, which may be independent of a stock market decline. China is a central command and controlled  economy which is becoming more free with the rising power of local government and the private sector. This transition will be halting and difficult. The true strength of our economies will be measured as we go through the coming problems.

Water as a Gift

Over the lives of our children and certainly our grandchildren it is quite possible that quantities of potable water will be more valuable than oil as our world evolves. Unless we change our dietary patterns our growing populations will consume more and more waters through the food we consume. At some point oil for transportation will be less important as we are going to be living closer together and will be using more fuel efficient vehicles. In a geopolitical sense we used to think that we in the US were blessed by having only two land borders, even though we have gone to war with those to our north and south. In the world that is evolving, our actual benefit is that we are abounded by the Atlantic, and Pacific Oceans and the Caribbean. Through the technology developed by a company now part of GE, we have developed the ability to desalinate large quantities of salt water if we can get enough electrical power. I am convinced that both the cost of electricity will decline and the price of water will rise so the North American countries will be well supplied with water.

Question of the week: Can you employ any of these ideas from this Thanksgiving message to your portfolio, life, or political beliefs?

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Sunday, November 20, 2016

The Longer the TIMESPAN, the More Bullish


Too bad more investors, particularly institutional investors, don't have the same clock in their heads as many successful entrepreneurs. As many of you already know that I believe one of my two great learning experiences was learning to handicap thoroughbred horses at the racetrack. One of the greatest jockeys of all time was Eddie Arcaro. He was said to have a very accurate clock is in his head. That is why he could win with different race strategies with different horses. For each horse he knew how fast the horse had to run in each portion of the race in order to win. Thus he was able to win with early sprinters as well as late come-from-behind racers. Many successful entrepreneurs have a similar clock in their heads. They know how much they need to accomplish in each period in terms of development of people, product, service levels, and key customers. In contrast, far too many portfolio managers only focus on the current performance period.

My evolving investment process is similar to the clock in the head approach. I learned as an entrepreneur that I could only accomplish a limited number of things in each month, quarter, year, five to twenty years. Thus, when I look at investing for clients and my family, I mentally assign investments to various future timespans in my life and beyond. This is why I developed TIMESPAN L Portfolios®.

This filtering system helps me address all of the myriad of inputs that besiege me every waking moment of everyday. I mentally assign various inputs to various timespans as to when they are most likely have the biggest impact on winning. I have often said that if you scratch a true analyst a historian will bleed. As a student of history I am well aware of the cyclical nature of price and value metrics. I am also aware that there is a general long-term trend of secular growth, thus far. The following is how I am viewing the various inputs that I am focusing on this weekend with both cyclical and secular patterns in mind.

The Immediate Term

This is the period that answers "what have you done for me lately" that various pundits in and out of the media chatter about. Any glance of price charts will count more reversals of direction in the daily versus five to twenty year charts. Thus the shorter period the more likely that it will contain more cyclicality. There are five particular inputs that I believe are worth thinking about.

1.  The media is broadcasting that equity mutual fund net sales has turned positive with the third highest dollar inflow in recently recorded history. Only the more observant reader will pick up that the entire positive inflow is coming in aggregate from Exchange Traded Funds (ETFs). Longer term mutual funds are still suffering from the aging demographics of their holders and a relative change in their distribution profitability and thus are still in net redemption. I believe the bulk of the ETF flows are from trading entities like hedge funds and do not represent a long-term commitment to the equity market. For example, on Friday after the Exchanges closed the two largest volume producers in the after-hours markets were the Financial Select Services SPDR and the S&P 500. Neither of these had much or any price movement. I believe the reasons for these trades is that there were some unfinished business in complex trading tactics of being short individual securities in these two good performing groups of stocks and the purchases of the ETFs was a hedging technique to protect the short seller from a group move upward rather than an individual stock from going down.

2.  Apparently the derivative traders en masse expect little chance of a major decline. The VIX contract's price has collapsed well below the average price paid over the years. As a contrarian, this makes me nervous in view of the recent sharp rise we have seen in the popular stock price indices at the same time as the sharp decline in high quality bond prices.

3.  Thomson Reuters reports on individual stocks within the S&P500 fourth quarter earnings estimates with 58 companies lowering their guidance and 29 raising them. Is this 2/1 ratio just a sign of traditionally lowering their guidance so they can announce a "beat" or are things not as good as the price trends suggest?

4.  When a former successful bear becomes an overnight bull it is worth recognizing. Stanley Druckenmiller who has a long history of successful management of two hedge funds and a major influence on one of the better university endowments, immediately after the election moved out of his bearish investments into being long the market. He has been a good reader of the market in the past.

The Short-Term

Unfortunately this is the time period that most investors think about. It is usually under three or at the longest, five years. While this period exhibits less cyclicality than the immediate term, based on history it is wise to expect at least one twelve month period of 10-25% decline. The major question to be determined for this group is whether we need a major bottom to occur before a substantial rise can happen. This concern has led too many portfolios to be concentrated in large cap stocks that trade in the US for US investors and multi-nationals for those outside.

Going back to my education at the racetrack when a significant number of jockeys change horses it may signify a common trend of significance. Currently I am conscious of a number of mutual fund portfolio managers leaving their shops often accompanied by closing some of their funds. In addition, there is a musical chairs phenomena of Chief Investment Officers leaving university endowment positions. Some of these moves are likely being caused by immediate poor investment performance, but not all as some are opting for a less tension filled lifestyle. Nevertheless as an old performance score keeper, these changes bring into question the validity of some long-term trends. This in turn may make fund raising somewhat more difficult. There is a deeper question. As many of the replacements will bring a somewhat to radically different investment approach, is this a classic example of shutting the barn door after the horses have left? Is it quite possible that when the liquidations of the old portfolios are complete that the discredited strategies will get their time in the sun?  Could this be another example of some securities moving from weak disheartened investors to stronger more future oriented investors?

Present Long Term Investors

In our lexicon we call these Endowment Portfolios. These accounts are structured to meet payment needs into the somewhat distant future. In a recent column in The Wall Street Journal, Greg Ip noted that the world has a structural savings surplus and a shortage of (worthwhile) investments. China and Japan this year will produce a savings surplus of about $850 billion. At the same time I believe that the world including the US has a retirement capital shortage of large and growing dimensions. As a fundamental believer in the genius of  marketplaces, I perceive the missing element is a traceable price structure. When we finally get high quality savings rates in the 4-5% range, possibly after taxes and inflation for term savings, and in excess of 8% for risk investments (again after tax and inflation) we will start to close the retirement capital underfunding. Whether the new administrations in the US and elsewhere are pro savings and retirement is yet to be seen, but I am convinced that some leaders will recognize the benefit of being an early adopter.

Under these conditions loans will carry sufficient credit buffers  to guide the borrowers to make safer decisions. This in turn will reduce the default risks which will eventually lead to lower interest rates. Both demographics and technology will be aids to finding the right systems solutions.

Legacy Inputs

The Legacy Portfolio investor is looking to create a stream of future benefits beyond the life of an investment committee or an individual. As in all transactions there is a more favorable time to be a buyer or a seller. I believe the current time favors the buyer of Legacy investments. There are fewer buyers so prices may well be more favorable than what they may be in the future. Why? In a very insightful analysis by James Paulson of Wells Capital part of Wells Fargo* entitled "Rising yields and stock market internals," he examines eight valuation factor ranges to determine why the bulk of investors’ money is where it is invested. His conclusion is "most (investors) have been chronically frightened by the future and therefore have opted to stay mainly domestic in large and traditionally more stable companies and in low volatility consumer and bond surrogate stocks." Almost by definition if that is where the heavy bulk of investors are they will get low returns as there will be fewer buyers to bid up their merchandise. I believe their absence, except in the private equity/venture capital arenas, suggests that prices of small innovative companies with strong owner/managements around the world are less bid for and thus are cheaper. In the words of the track they are “under bet.”
*Owned personally and in the private financial services fund I manage, plus the fund owns Berkshire Hathaway that is a 10%+ holder of Wells Fargo.

Questions for the week:

1.  Are you changing your investments due to political changes?
2.  How do you handle the inputs that you receive in terms of your investment actions?
Did you miss my blog last week?  Click here to read.

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Copyright © 2008 - 2016
A. Michael Lipper, C.F.A.,
All Rights Reserved.
Contact author for limited redistribution permission.