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This Weekend’s Learning Sources - Weekly Blog # 939

Mike Lipper’s Monday Morning Musings

This Weekend’s Learning Sources

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

Identifying sources of learning

One of the main differences between us and most animals is that our brains are larger, which hopefully means we can learn more. The end of this week supplied three sources of learning. The three teams of instructors were: Tim Cook (Steve Jobs), Berkshire Hathaway’s Annual Meeting with shareholders (Warren Buffett/Charlie Munger and Greg Able), and the Bettors and Horses at the Kentucky Derby. From each I can learn a lot. Matter of fact, each could be a whole semester at Business Schools instead of what they are currently teaching.

Tim Cook (Steve Jobs)

At the end of the so-called work week Tim Cook conducted what was his last quarterly meeting for shareholders and analysts of Apple (*). He focused on the company’s critical relationships with customers and what is owed to them. He stressed what Steve Jobs taught, the betterment of the users’ lives. These were the critical thoughts passed onto the oncoming new President of Apple. We should pass these views onto all we deal with, focusing less on what they paid us and more on what we did for them.

* Owned in personal and client accounts.

Warren Buffett/ Charlie Munger & Greg Able

Mr. Buffett spoke to many of the shareholders attending the annual Berkshire Hathaway (*) meeting, both in person and electronically. His advice for people reaching 50 years or older was to switch their primary investment focus from making money to capital preservation. He emphasized saying no, particularly to not well understood new investments. (I do not own any “AI” stocks directly, but there are many in mutual funds I own. The key to their future is what they have yet to produce, not what they are selling today.) He believes investors in retirement should prune their holdings and try to explain what they own to their heirs, feeling it is more beneficial to focus on how the inheritance should be used rather than the intricacies of what is owned.

* Owned in personal and client accounts.

Greg Able is the new President of the company and is focused on improving the operations of the company. When the talented Chief Financial Officer transitions into retirement, he will be replaced with both a CFO and a new lawyer. Furthermore, for the 31 private companies owned by Berkshire, he has appointed a trusted internal executive as leader. Instead of doing just financial oversight, he will be reviewing the operations of the formerly private companies. Good policies of the past will be reviewed to see if they are right for now.

My personal view is that there are two major trends which we did not have to deal with in the past, but which could be much more important in the future. The first is one of the causes of financial and economic cyclicality resulting from not repaying debt on time and at full value. Defaults on debt have led to depressions in the past and have been the cause of unplanned contractions.

In the decade of the 1920s into the early 1930s society encouraged the global extension of debt at the retail level, including its use as a defense against tariffs (Smoot Hawley). Currently, we have an expanded federal debt led by someone who needed to renegotiate his own debt. Our government encourages investing retirement capital in debt. The national debt is larger than the GNP. (Old debt has a due date, while GNP is produced each year.)

The second dangerous trend is the value of the dollar in world trade. As debt grows, overseas investors value it less. Meaning, it not only becomes more expensive for funding our debt, but also for paying for imports of food, clothing, and raw materials. We are better positioned than many other countries who are in worst shape, but not all. Asia, which has a younger population and a disciplined workforce, is in better shape. Higher inflation leads to lower long-term value of the currency. One measure of inflation not issued by our overworked government is the ECRI Index of Industrial Prices, which was up 140.35% this week for the last 52 weeks.

Kentucky Derby

I brought this on myself by stating that I learned the basic tenants of analysis at the New York Racetracks. A subscriber asked who I was betting on in the race. Where do I begin? Perhaps with two axioms. First, as with most things in life, short answers are often wrong. The short answers are wrong because they are stated without limits and conditions. That brings us to the second axiom, I don’t like losing. I don’t like losing because it is a double loss. The first loss is the sum wagered, and the second is the loss of funds necessary for future betting and other things.

There are two negatives against betting at the track. First, the track takes a cut of all bets and there are personal expenses of travel, admissions, and food. Second, as a game of chance it is rigged because of the track’s take. Additionally, winnings are taxable at federal and state levels. There is still another drawback, about 30% to 50% of the time the lowest yielding horse wins. Most of the time those winnings are not large enough to offset losses and expenses incurred. I address this problem by limiting the number of times I bet, usually 3 out of 9 races and rarely at the lowest odds. The advantage of this approach is staying away from betting at the lowest odds, which are the most popular horses.

If these issues did not cause you to find other things to bet on, the elements of the Derby might. First, the race is only for three-year-old horses. While horses are born for the record throughout the year, under racing law all horses are born on January 1st. Some horses start their racing history at 2 years old, but many do not. By the time they are three years old they are adolescent. (From a scientific standpoint it would be useful to know the actual date of birth. There is poor but available information as to the number of official races the horse has run. In terms of the Derby, the range I heard was 1 to 4 races.) For those of my age, I am reluctant to take adolescent horses and most humans seriously.

So, after all this I did not place a bet on this year’s Derby. Most of the time I am not interested in races for three-year olds that are run any earlier than June, which starts with the Belmont Stakes race. These races are also a bit suspect because the course has been altered.

I would not have bet on the winner this year. However, the trainer deserves to be congratulated as she was the first woman trainer to win the Derby. The night before she had a dam which won the Kentucky Oaks with the same jockey who won the Kentucky Derby. Quite an accomplishment.

All of this shows I am still a student and hope you are as well.

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

Mike Lipper's Blog: Watch Out for the Four - Weekly Blog # 938

Mike Lipper's Blog: Investors’ Interlude - Weekly Blog # 937

Mike Lipper's Blog: Not Yet Ready for a long-term Solution - Weekly Blog # 936

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Watch Out for the Four - Weekly Blog # 938

Mike Lipper’s Monday Morning Musings

Watch Out for the Four

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

Preface

As subscribers have been told, I am shifting my focus to investing for long-term gains, hopefully for multiple generations. This is the time to begin searching for future winners, although it’s not the time to begin serious buying. If you are like me, at times it can be difficult to only follow an investment intellectually. I need to own a small amount so that I go through all the relevant info while awaiting the time to begin a meaningful buy program.

Timing May Not Begin Until:

The beginning of the buy program will not start until people and the data change. In terms of people, there are four structural leaders. These are the men who wish to change the future and are governing to do that. They lead and largely dictate activities in the US, China, Russia, and North Korea. Only the last one, North Korea, is preparing to eventually pass the torch of control to a very young daughter. In each case the eventual leader will be different than the present leader and will have to exert power to stay in place. Any of these replacements could have input into future global investments. Because of the similar ages of the first three, investors will be faced with cross currents that will make choosing investment policy difficult.

Before these leadership transitions occur, the global economy is likely to change multiple times. I expect we will be dealing with the terrible “4s”* at least some of the time. The data series likely to experience major swings are inflation, currencies, and taxes, among others. Changes to these data series may not be dictated from on high, but in the marketplace. Additionally, secular changes in demographics and technology will have an impact on how people act and feel.

*Terrible 4s are 4% for inflation, unemployment, and dollar decline, leading to an S&P 500 price that starts with a “4”. A high 4 signals a recession and a low 4 a depression.

What Can We Do Now?

First, we can pay attention to what people are doing, not saying. Actions speak louder than words. While the media is full of pundits talking about market indices at new highs, 58% of the stocks on the New York Stock Exchange (NYSE) fell in the latest week. Perhaps more meaningful, 56% of the stocks fell on the NASDAQ. A survey of investment advisers and their clients found advisers twice as bullish as their customers.

Second, be aware of financial and economic history. We know that historic patterns don’t exactly repeat, but directionally they are pretty accurate. Economic cycles are based in part on the level of debt being created throughout the system. (Government deficits need to be considered as well as business debt, personal debt, and accidental debt.)

When debt repayment becomes too burdensome it won’t be promptly repaid and will cause purchasing power to drop and fixed income/equity markets to decline. Depending on the severity of the decline it will be called a recession or a depression. The frequency of recessions is normally five to ten years, suggesting one is due. A depression is much more serious and infrequent, usually every fifty to one hundred years. Depressions are often caused by mismanagement of an economy in a recession. We have not had a depression for ninety years and some believe the last one brought on WWII. The key for us is knowing that these occurrences are possible and being aware and ready to change behavior.

While Waiting

The present should be devoted to looking for stocks to buy for the next expansion. A study of the past suggests the leaders of the next cycle will be quite different than the present. Bearing in mind that many children born today will need retirement money 100 years from now, the odds of most large companies surviving is not good.

There are lots of ways to choose stocks to research. None of them are perfect and they will change over time, so investors should always be learning what will cause change. From time to time, I’ll pick one approach to explore briefly, so keep tuned to find an approach that helps you.

Acquisitions

No solution is perfect, and conditions change unpredictably. It is normal to change our choices after looking at the cards we are given. The easiest approach is to add a new holding and temporarily retire a present holding. Additionally, no one plays the investment game without making periodic acquisitions. Unfortunately, many investors fail to discard some part of what is not working. This habit of adding without discarding leads to an ever-increasing number of acquisitions, which in most cases leads to average and eventually below average results.

I have never seen an acquirer who couldn’t benefit from getting more talent, often with different characteristics than their existing talent. I have often found it better to buy a company for management and tax purposes, even if it’s for a single individual. It has worked for me, even when it was a bad choice. It is easier for me to make a bad choice than to fire an individual or a small group who I like as people, but not as workers and co-venturers. I am comfortable with the way Apple often buys tiny companies, compared to others who acquire much larger companies with all sorts of personnel problems.

I was speaking with the manager of a small unit in a very large company who wanted the unit to grow by hiring more people doing the same thing his present employees do. That may be efficient in terms of output, but it just adds to existing problems. I would not view this situation as growth but view it as adding new machines. If on the other hand the new people brought new talents, they could serve a different group of clients who had different needs, which is real growth.

There are some companies who try to grow by buying distant operations, adding resources outside their prime geographical area. I do not view this as growth of talent either, but as getting more copies of existing machines. They would be adding to present capacity but not getting new talents that could open new markets. For me they are not growth engines but merely machine acquirers, which will not be valuable talents as the business changes. Investors can see which type of stock I would acquire, even at somewhat of a premium price.

Question: What do you think about my approach?

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

Mike Lipper's Blog: Investors’ Interlude - Weekly Blog # 937

Mike Lipper's Blog: Not Yet Ready for a long-term Solution - Weekly Blog # 936

Mike Lipper's Blog: We Have a Management Problem - Weekly Blog # 935

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Investors’ Interlude - Weekly Blog # 937

Mike Lipper’s Monday Morning Musings

Investors’ Interlude

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

Take Some Gains Before Taxes Do

The common denominator for most big investment gains are changes. Usually changes in investor perceptions and economic structural changes. The Standard & Poor’s 500 (S&P 500) and NASDAQ Composite are at record highs, due largely to enthusiasm for announcements related to the suspension of fighting in the Middle East. (This is not true for the Dow Jones Industrial Average (DJIA) and the average stock. Unfortunately, since WWII the US has had a history of winning wars but losing the peace.)

We do not know the total cost of the war and other spending, including election-oriented payments. I suspect the President’s desire for a lower valued dollar will be achieved. There is also a strong push from urban legislators for “fair taxes”, also known as “tax the rich”. Thus, I believe capital gains rates and estate tax rates will rise.

Due to these expected changes long-term investors should review their portfolios to see how much of their wealth should be realized before their estates are taxed. If this generates significant amounts of cash, I suggest maintaining the cash or short-term treasury holdings for reinvestment.

I believe there will be positive changes in the foreseeable future. These changes may be driven by technology, demographics, immigration, and global factors. These changes are likely to be net larger than politically motivated changes and you want to be in position to take advantage of them.

Investment Impacts of Past Changes

The Founding Fathers were afraid of the powers of government, so they placed our Capitol in the humid swamp of Washington DC, thinking our legislators would desert the “swamp” during the humid months. That worked reasonably well until the development of air conditioning. The end of the government’s year is now September 30th, after the summer political conventions, which reduces the time for debating many of the critical issues of the day. DC is now a year-round city for government workers and legislators. Many work or live in large buildings constructed and possibly owned by real estate families who are probably wealthier than the US Senate members. Thus, the advent of air conditioning changed how our government works.

Another unexpected change was the railroad growth of the late nineteenth century. The highly regulated railroads only made profits on freight travel and lost so much money on human passengers that the federal government became the principal owner of passenger travel. The freight lines are governed by both the Department of the Interior and Anti-Trust laws. This has led to other countries having better and cheaper train service than we do, paid for by charges on the goods we consume. It is interesting to note that the Dow Jones Transportation Index, which covers the rails, was the best performing market index this past week. The rails are still important.

Future Changes

We live in an environment of an increasing rate of change. I leave to others to identify the changes which most investors would not be surprised by.

Geographic Changes

Western Hemisphere countries have become more partners than adversaries in terms of trade, health practice, external and internal defense, probably led by Canada.
Russia, after Putin, will experience major political and economic changes.
Asian countries that border both Russia and China will come into their own in terms of trade and be more open to development.
African countries will welcome joint development from Western countries.
Indonesia and India will become less autocratic, with foreign companies able to generate substantial sales and earnings.
Each country will make their own rules.

Retirement Issues

Over time, US Social Security will be allowed to exclude US government paper and possibly approach being a foreign wealth fund.
It is reasonable to expect that those born recently will live to at least one hundred, so we will need to provide for longer periods of investment and spending.
For the same reason, private retirement vehicles will need to change.

Market Regulation

Using the last trade may no longer be appropriate if it is too small and unrepresentative of the size of the seller.
As more stocks and possibly bonds trade in size in after-hours, having a closing price on the exchange market may be unrealistic.
From a technology perspective, there should be a body that can approve of their use for retirement accounts.
Should issuers of a certain size be required to have assets or insurance on the life of the CEO that can be used in retirement accounts.

As usual, I would love our subscribers to share their views with me.

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

Mike Lipper's Blog: Not Yet Ready for a long-term Solution - Weekly Blog # 936

Mike Lipper's Blog: We Have a Management Problem - Weekly Blog # 935

Mike Lipper's Blog: Is History Rhyming Again? - Weekly Blog # 934

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Not Yet Ready for a long-term Solution - Weekly Blog # 936

Mike Lipper’s Monday Morning Musings

Not Yet Ready for a long-term Solution

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

Preface

I was hoping to start a series of blogs on the selection of smart securities investment strategies for multi-generational ownership. Unfortunately, the current data does not lead to a positive view. The breakdown of the twenty-hour cease fire negotiation with the Iranians confirms that this was a week of data confusion. The historical odds were against progress in the search for political and economic solutions.

Our Side

The investment mode for the week is captured by the changes in the American Association of Individual Investors (AAII) sample survey of the next six month’s market outlook. The bullish outlook improved slightly to 35.7% from 33.6% the prior week, a gain of 2.1% in a not highly disciplined survey. What is perhaps a little more insightful is a drop in the bearish measure to 43.0% from 51.4%, a decline of 8.4 %. During the survey week, many pundits were enthused about the forthcoming ceasefire meeting. (I expect Sunday morning’s announcement of a failure to get an agreement will materially impact this coming week’s results.)

The two largest stock market exchanges reflected different views, with only 31% of NYSE stocks falling vs 53% of NASDAQ stocks declining. (The NASDAQ market has younger, more speculative companies, with a larger number of companies reporting losses, including some private debt funds.)

Consumer sentiment was reported to be lowest in 70 years. Moody’s (*) raised the chance of a recession in the next 12 months to 48.6%. One of their executives is quoted as saying “we could already be in a recession”.

(*) Owned in managed accounts.

Iranians’ View

The first thing to remember is that Iran is the modern name for Persia, which was the dominant political/military power in the Middle East for hundreds of years. Persia was briefly lost to Alexander the Great and later to the Ottomans but was never effectively occupied by foreign forces.

The current view of the Iranians is that Trump is losing this war. He is driven to achieve a quick victory to guarantee a positive mid-term election this year, at least in the House. The Iranians are believers in the German strategist Carl von Clausewitz’s statement that “war is an instrument of policy by other means”. Our President went to a military high school, but I believe he at best learned infantry tactics, not strategy. He did not participate in the ROTC at University of Pennsylvania. The current Secretary of War did not have any professional exposure at West Point or VMI and thus was not schooled in strategy. One of Clausewitz’s beliefs was getting the other side to give up the will to fight. Unfortunately, since WWII the US has won wars but lost the peace in getting their opponent to give up the willingness to fight. The last time we achieved it was through the Marshal Plan, named after General George Marshal a graduate of VMI who rebuilt the industrial strength of Germany.

While the potential for nuclear warfare was a concern, the far greater risk to the US, Britain, Europe, Mid East, Africa, Latin America, and Asia were already active sleeper cells. At this point we have not yet organized an effective counterforce.

It is no wonder the weekend discussions did not produce positive results. Consequently, it may be too early to invest new long-term money.

These are controversial views. Please exchange your thoughts. I am always a student and need to learn.

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

Mike Lipper's Blog: We Have a Management Problem - Weekly Blog # 935

Mike Lipper's Blog: Is History Rhyming Again? - Weekly Blog # 934

Mike Lipper's Blog: Bifocal Analysis: Short & Long-Term - Weekly Blog # 933

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We Have a Management Problem - Weekly Blog # 935

Mike Lipper’s Monday Morning Musings

We Have a Management Problem

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

The Founding Fathers Saw it

When unsuccessful in getting George Washington to accept the title of King they decided to name him President, a person who presides over others that are powerful. Notice, they did not choose Executive or Manager. Interesting.

Today, the elected leader of the country comes from the commercial world and governs as a Chief Executive. Interesting. The difference between the two labels is that the presiding officer needs to work with other elected officers and not command his or her views become absolute commands.

Different Styles = Different Results

The largest owner/leader of a private family company has only the marketplace or regulator that prevents almost complete dictatorial power. This is reinforced by having family members in the named positions. It is worth noting, rarely if ever is one of the senior family members hired away to run a separate public company. Interesting.

One of the realities of managing a successful company is that senior people are often hired away to run competitive companies. GE, JP Morgan Chase*, and Apple* are good examples.

* Indicates shares owned in personal and managed accounts. Interesting

The Selling Problem

Emotionally, selling is much more difficult than buying. Afterall, buying is an act of new faith in both a stock and the individual making the decision. At the time of purchase the stock position is the single best bet the investor can make.

Selling sometimes involves disappointment in the stock or can be the need for account liquidity. It is like the pain of selling one’s children or losing a personal extremity, but at the time of sale it is the least loved stock in the portfolio. Emotionally it is relatively easy to set up a buying program that purchases a position over time, such as buying a certain number of shares each month for the next year as one gains conviction. However, selling is an entirely different mindset as it is painful to lose a limb or a child, the quicker the better. That may be why more shares have been sold at declining prices on down days for the last six months. Since selling is more emotional it probably makes tactical sense to sell over time. Interesting

Reasons to Consider Selling Programs

The US has the highest inflation rate of all the advanced economies.
Iran has a functioning economy, despite the bombing.
There are only 3 mutual fund sector averages that beat the +13.66% 10-year compound average of S&P 500 index funds; Science & Tech +17.82%, Precious Metals Equity +16.77%, and Large-Cap Growth +14.61%. My guess is that it is unlikely these three sectors will outperform the average US diversified fund’s return of +11.16%, nor will they produce double digit gains in the next 10 years.
The “Hyperscalers” are commodity players that depend on the long-term prices of fuels for their plants.
The Walmart (stock) Recession Signal +10.89% vs the S&P Luxury Price Average -14.8%.
Fixed Income strategies in the future won’t follow historical patterns.
The President has borrowed the most money and runs the government with biggest deficit. They are urging retail investors to buy debt securities.
Ray Dalio believes in the histories of recessions, concluding we are currently in stage five on the way to six.
Fitch has noted that the default rate on private debt has risen.
The ECRI industrial price index has risen to 135.06, which is a +14.21% increase in the last 12 months.
Note: The job gains for March included jobs for healthcare, which require larger amounts of social assistance and produce less GDP per person.
Homer Jenkins Jr. noted in the WSJ that “Trump is a lame duck with low appeal and a surplus of voter distrust.”
We won’t have peace in the middle east until Iran’s sponsorship of death and destruction in the US, UK, Europe, Mideast, Africa, and Asia ends.