Mike
Lipper’s Monday Morning Musings
The
Inevitable Recession
Editors: Frank Harrison 1997-2018,
Hylton Phillips-Page 2018
Loses Are Needed
Securities analysts, portfolio managers, investors,
politicians, and others, need the fear and reality of recessions. Both written
and geological history record meaningful and painful declines. Since they
happen with some regularity there must be a repetitive set of reasons, with the
lure of a gain sucking us into overexpansion and other error-making decisions.
Humans evolved from hunters and/or gathers, who periodically
generated supplies beyond their immediate need, beyond a limited reserve for
emergencies. When they gathered too much, costs grew and quality suffered. In the
financial world we hoard and or borrow too much in the way of financial assets.
This became increasingly clear as conditions changed.
These adverse conditions are clear in recorded history, in
Babylon, China, and other places. Thus, the history of weather, business, and
political cycles were written, becoming critical drivers of financial markets.
The Rise of Financial Analysis
Trading markets began soon after communities were
established. Over time, it became clear that some successful traders achieved
periodic, large returns on their use of trading capital. A number of these people
gained reputations as good traders and found other people who recognized they
did not have the same skills, contacts, and capital. These traders could borrow
money at attractive rates and could charge fees to manage portfolios for
selected outsiders. A number of these traders evolved into investment banks,
who had both skilled traders and statisticians, some of whom became analysts.
US and UK Governments vs. Fraud
When markets fall, investors don't blame themselves for the losses
they sustain. They claim fraud on the part of the "system", which
includes issuers, exchanges, underwriters, and salespeople. Generally, the public
investor does not understand business and financial cycles or chooses to forget
the warnings that were given before they placed purchase orders. To protect the
"public", disclosure and other laws were passed. While no law or
regulation can prevent bad judgement, disclosures can ensure investors receive what
is required to be transmitted to them. Unfortunately, accounting and legal disclosures
use terms that the public does not understand.
As a result of large losses sustained by US public investors
in the 1930s, there were seven reform laws passed, including the Securities
& Exchange Act and a similar set of regulations in the UK.
The Development of Securities Analysis
While there were numerous books written about investing
prior to the 1929 crash, they were not read by many investors. In the early
1930s Benjamin Graham and David Dodd wrote a Securities Analysis
textbook for a Columbia University course. (Ben was a portfolio manager and Dave Dodd was a professor, who was still teaching in the
late 1950s when I took the course from him.) Their main lesson was how to think
about investing in securities while minimizing losing money. The course was
taught as a supplement to a number of accounting and business law courses. They
largely used the reconstruction of financial statements to assist patient investors.
(While useful in minimizing investment losses, creating language to allow people
to understand the thinking of others and the politics of an industry or client
would have been more valuable.)
Recession Analysis
I believe most of those in the market are assessing the probability
of an oncoming recession by focusing on published economic data. The stock market
is focused on the future, not the past, and in that way it’s ahead of the
economics releases. For example, the election results of last Tuesday suggest Louis
XIV’s building of Versailles, even though no one else is saying it. The King was
always at war, usually with England, and ran up big debts. He destroyed the
local power of the nobility and insisted they spend most of their time
attending to him in the Palace. (Is the reaction to larger than expected Democratic
margins of victory in New Jersey and Virginia and the destruction of part of
the White House for a big ballroom similar to what Louis XIV set in motion before
the French Revolution and Napolean?)
Other market indicators last week included decliners on both
the NYSE and NASDAQ being larger than gainers, with the NASDAQ losing twice as much
as the gainers. NASDAQ's volume over the last year increased 38.21% vs the NYSE
volume gaining 22.98%. (One of the clues to identifying a peak and then a
decline is a decline in "quality", which is better evidenced on the balance
sheet than through earnings.)
On Friday, the best performing mutual fund categories in rank
order were Currency funds, Precious Metals Funds, Real Estate Funds, Natural Resource
Funds, and Materials Producers. All are not heavily held by funds and other institutional
holders. On a year-to-date basis, the only fund categories that beat the
S&P 500 Funds Index category were Science & Tech, Precious Metals,
Global Science & Tech, and Large-Cap Growth. (There is considerable overlap
in the names in their portfolios). Barron's weekly list of foreign market
indices showed 5 Asian markets up, with only 1 rising in Europe.
Identifying the date when a recession begins is officially only
determined after it ends. As a practical matter you might use the purchasing
managers' index, which has been in contraction for the last 8 months and is now
showing only 42.3% rising. While it is foolish- to name both a market direction
and a date, it may be useful to be aware that the market generally rises at
least 80% of the time. Considering the 5-year average length of time CEOs remain in their chair, it
suggests a market decline once every five years, which somewhat parallels the 4-year
length of a US President's term. (I don't know how to adjust the number for the
current President but possibly averaging all Presidents it may be around five
years.)
Working Conclusion:
The odds of a recession before the next Presidential
election is probably 67%, with a depression at 50%. (The latter would require some
mismanagement during the recession to raise the odds of a depression above 50%.)
Did you miss my blog last week? Click here to read.
Mike
Lipper's Blog: Biggest Investment Hurdle: Complexity - Weekly Blog # 913
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Lipper's Blog: Where Are US Stock Prices Going? - Weekly Blog # 911
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