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Warnings Increasing - Weekly Blog # 943

Mike Lipper’s Monday Morning Musings

Warnings Increasing

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

Preface

I cannot predict the future, and I believe none can. The best I can do is use a life-long habit of dealing with chances of what may happen. In other words, odds are one possibility is more likely than another.

We all hope that the various problems facing the financial world will be quickly solved to our personal benefit. However, as a trained analyst I am compelled to increasingly doubt the expressed views found in most US media and by other pundits which are not completely echoed beyond our borders. These items came out last week.

Worry List in Chronological Order

The number of farm bankruptcies rose 40%. (The same thing happened before the depression.)
The University of Michigan Consumer Confidence Survey dropped to 93.1 from 93.7.
Another Fund Management Company is looking to find a new home - Dimensional Fund Advisors. (I expect there will be others.)
Perella Weinberg, an investment bank, is laying off 10 partners and 10% of the firm. (More to come?)
Gary Shelling predicts a 30 % chance of a S&P 500 bear market in 2026 and a 60-70% chance in 2027.
Canada has economically contracted for 3 of the past 5 quarters, falling into a recession. (The US is their largest customer, and our companies own lots of Canadian companies.)
Prudential Insurance, Meta Holdings, and Johnson & Johnson, are compelled to announce layoffs.
On Friday, the last day of the month, more stocks were sold on a decline on both the NYSE and NASDAQ. However, this may be typical selling before the weekend.
In May only three S&P 500 sectors rose: InfoTech+5.6%, Consumer Discretionary +0.26%, and Healthcare +0.21%. Eight sectors fell.
The three forces that led to the market index rising were: Affluent Consumers, “AI” investments, and Asset Allocation. (Contrary points: Inflation was up more than wages. Other industries that were similar and didn’t work out: canals, railroads, radio, airlines, atomic energy, and computers. Bonds were a safe way to beat stocks and “private debt and equity”)

Warning: Be Careful, Let Others Have Some of your Winners.

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Mike Lipper's Blog: Rhymes + Future Opportunities - Weekly Blog # 942

Mike Lipper's Blog: Many Trends Within the Same Market - Weekly Blog # 941

Mike Lipper's Blog: What Can Go Wrong - Weekly Blog # 940

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Rhymes + Future Opportunities - Weekly Blog # 942

Mike Lipper’s Monday Morning Musings

Rhymes + Future Opportunities

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

Truths

From the beginning of human evolution, elders have instructed the young with real and imagined tales of history. For the most part, the speakers were survivors or were protected by survivors. The smarter of the young learned two things, histories tend to repeat, but not exactly. This is where the rhyming came in. Only the very smartest of the young learned that there were tales by losers. To continue being a living survivor the truth in many cases was disguised, as it was more threatening than going into combat. Many passed on their knowledge of events through playwrights, actors, singers, producers/directors and students of the past as made-up dramas.

It is too bad that most historical dramas are not taught with a deep understanding of the politics and economics of the day. Matter of fact, that is probably how a skilled professor should teach economics. There is a risk in doing so, as we prefer tales of winning rather than why things happen. Notice that today major TV programs and theatrical productions are produced by organizations dependent on others for capital and licenses.

With that as perspective, please look at William Shakespeare’s Merchant of Venice. By the time he produced the play he was a favorite of the British Crown. From an economic point of view the play was opposed to the creation of debt and the timing optionality of repaying debt in unfortunate times. Now, substitute the crown for the debtor in borrowing large sums of money for war making purposes.

Does that ring a bell with the current President, who is a personal user of debt and urges businesses to delay recouping wrongly structured tariffs? The bigger problem is that most nations are similarly staying in power by doing somewhat similar things. They are behaving as other members of society do, e.g. businesses, non-profits (particularly universities and hospitals), and retail individuals. In business courses we should teach the proper way to create, manage, and use debt. (I don’t think it is taught at Wharton, where the President attended, or perhaps he didn’t take the class.)

The Growing Problem

The following are statements from others related to the problem:

Barron’s - “Higher bond yields provide competition for stocks.”
The CBO predicts a federal budget deficit of 5.8% in 2026 and 6.1% for the entire next decade.
“JP Morgan looks to reduce exposure to $4 Billion in private equity-linked loans.”

Longer-Term Opportunities

After the debt problem has been delt with, I look forward to a favorable period for equity investing. The following are brief comments that show some hope for gains.

Earlier this year the only mutual funds enjoying substantial gains were precious metals funds and those invested in “AI”. Currently, performance leadership has broadened out to industrials, some financials, and some international stocks traded beyond our borders. Currently, the mutual fund averages in twenty-five sectors out of one hundred and five are doing better than the average S&P 500 index fund.

The Financial Times discussed the investment success of Chris Hohn, a very successful British hedge fund manager. In many ways his portfolio is like the portfolio Warren Buffett and Charlie Munger put together, in terms of its concentrated positions. However, Chris Hohn excluded some industries from his portfolio that Berkshire had used in the past, like banks, utilities, media, and insurance. Both he and Berkshire Hathaway (*) like monopolies and duopolies and spend a great deal of time studying the barriers to entry for the companies.

* Stock owned by personal and investment accounts

One of the largest industries critical to the health of the world is the healthcare industry, which is selling at its lowest price since 2000. This is a difficult industry for me to directly invest in. Picking the winner requires a good understanding of what is being developed in their own and competing laboratories as well as the rules likely to be issued by various government agencies. The way we participate is by using mutual funds that have appropriately qualified staff.

One stock we own for the next bull market is Korn Ferry (*), a leader in employment management. We see it an “ultimate income” play for “AI” layoffs. It has a medium yield.

* Stock owned by personal and investment accounts

We are looking for more stocks for the next “bull market”.

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

Mike Lipper's Blog: Many Trends Within the Same Market - Weekly Blog # 941

Mike Lipper's Blog: What Can Go Wrong - Weekly Blog # 940

Mike Lipper's Blog: This Weekend’s Learning Sources - Weekly Blog # 939

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Many Trends Within the Same Market - Weekly Blog # 941

Mike Lipper’s Monday Morning Musings

Many Trends Within the Same Market

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

Preface

The purpose of this preface is to share my long-term thinking, which in part drives my current investment thinking. There is no better portfolio manager thinker I have known than Peter Lynch, who produced a stellar performance record with a large equity mutual fund over the 1977-1990 period. One of his beliefs was “Know what you own, and why you own it.”

One approach to investing is to be index aware or agnostic. My approach is different in that it recognizes that all security prices are cyclically dependent due to both the expressed attitude of the individual stocks for security and to the market in general. My focus is on the client, recognizing that they often have several perceived competing needs.

For multi-generational accounts, long-term performance volatility is as important, if not more so, than simple performance, because it can shake people’s confidence. Volatility multiples focused on by pundits in the press can scare investors into dumping well thought out positions.

In many cases, accounts that are managed serially by members of the family have good results, often due to patience and having seen volatility in the past. There are a handful of globally managed accounts that have worked reasonably well, which have both low volatility and good long-term performance.

For future oriented accounts the selection process does not depend on the present roster of products. New products, or more germane new ways of filling critical needs can help companies become leaders in their fields. Apple (*) is one such company, although you should be aware that this approach can lead to failed products or approaches at times.

* Owned in client and personal accounts.

In today’s markets the primary way to avoid equity losses is to invest in fixed income securities, which often have higher yields than current short-term rates due to investing in lower quality or longer maturity bonds. This approach may lead to unexpected losses from higher interest rates, which might be discouraging and defeat the very purpose of temporarily getting out of the stock market, which is to have a buying reserve. I prefer short-term, under two-year maturities, or in a few cases middle yielding bonds with low price/earnings ratios. In the latter case, you should be willing to sell these bonds after a major market decline, even at a loss, to get cash to invest in stocks that are more growth oriented.

There is risk in the growing amount of debt being undertaken by governments, companies, and families, because of depleted accident/emergency reserves. This could lead to a situation we have not seen in 95 years. A significant change in the structure of the global economy that could take an extended period to recover from. Moving further in this direction should cause us to enter a period of reflection, recovery, and renewal. We need to be aware of the possibility that this structural change might happen.

Now a View of the Current Situation

If you look at what is being reported in the current media, you might think “the market” has a bullish future. The truth is, during the latest week on the “Big Board” only 745 stocks, or 26% rose. Even on the on the more speculative and shorter-lived NASDAQ Composite, just 31% of the stocks were sold at higher prices.

For those who have been trained to look at bond yields as a predictor of future stock prices, the average yield of ten high quality bonds picked by Barron’s rose 15 basis points for the week, while a group of medium quality bonds only rose 5 basis points. Rising bond yields mean lower bond prices, which is negative for stock prices.

Two companies I follow are Berkshire Hathaway (*) and McKinsey. Berkshire reduced the number of stocks in its portfolio while simultaneously buying its shares at 144% of book value. McKinsey, a privately owned company, preserved cash by cutting cash dividends and increasing equity distributions to its partners.

* Owned by managed accounts and personal accounts.

I pay particular attention to the performance of mutual funds. On a year-to-date basis through Thursday, 38 of 103 fund sector averages beat the S&P 500 Index Fund average. It has been very difficult to beat the performance of the S&P 500 Index for the past 10 years. Only 3 sector averages have accomplished that, and they were all driven by investor enthusiasm for “AI”.

The same thing happened among the leaders overseas, where a 1/3 of the emerging securities had some activity in “AI”. This was particularly true in Taiwan and South Korea. AI labels, where the company is headquartered, should be viewed with caution, as we don’t know what percent of the chips and computers eventually land in the US.

One final statistic that I follow is the index of industrial prices put out by ECRI. For the week the index finished at 145.33, up from 142.00 the prior week and 32.58 12 months earlier. Obviously, problems in the Strait of Hormuz and other supply chain issues played a role in the increase.

Final impression

All investments appear to have increased risks. So please be careful.

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

Mike Lipper's Blog: What Can Go Wrong - Weekly Blog # 940

Mike Lipper's Blog: This Weekend’s Learning Sources - Weekly Blog # 939

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

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What Can Go Wrong - Weekly Blog # 940

Mike Lipper’s Monday Morning Musings

What Can Go Wrong

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

Preface

In preparing to start a buying program using one of the lessons from betting at the track you should recognize what could go wrong. The purpose of this blog is not to permit betting, but to avoid wagering on one’s ego and failing to learn from the experience.

There are four general reasons for not seeing an opportunity as a trap.

Not appreciating the goals of the source.
Inaccurate data or badly displayed data.
Failing to process past mistakes.
Too difficult to fathom. (Probably the least in terms of occurrence)

Tocqueville, as quoted by Goldman Sachs who deals well with errors. “The greatness of America lies not being more enlightened than any other nation, but rather her ability to repair her faults.” Therefore, I view betting on horses, securities, politics, people, and many other things, as learning experiences.

Sources of Mistakes

We all have deeply felt biases. The media and their chorus of pundits use information to motivate repeat use of their work. Thus, they transmit their pronouncements in the way we would like to read, see, or hear. For example, in the latest announcements of the number of people hired, it was better than many expected compared to the prior, shorter month, with bad weather. Deep in the article was the fact that it was not better than the same month last year. Furthermore, if you deduct healthcare and social assistance workers from the total employed, there has been no growth since 2024. Why is this important? The latter group receives payments from the federal government, either directly or indirectly, which will likely have some impact on the midterm elections.

This is probably a major reason for the various market indices going up. Using the data for this week only, 2/3rds of the stocks advanced and 1/3rd did not. Even on Friday, there was little focus on the number of new unemployment claims, which rose for the week. There was little coverage of the consumer sentiment survey by the University of Michigan, which hit a new low.

When companies release layoff numbers, they are vague and rounded. What disturbs me is that these are some of the most numeric-driven companies: Fidelity, Deloitte, and Commerzbank, all of which announced cutbacks. For some time, established financial and auditing firms around the world have been retiring senior people without hiring replacements. Even some “AI” people have been let go.

One of the most dangerous items of news is a shortage of an industry’s goods followed by a new large supply becoming available. Historically, look at what happened to the price of gold when the size of the Latin American precious metal was announced. While it made Spain wealthy, it hurt the other European nations with lots of gold in their vaults. So be careful if quantities jump up while simultaneously being withdrawn.

What We Should Have Learned?

Perhaps we should have learned from recorded history the need to negotiate debts payments, date, and rate! Examples include the Babylonians, William Shakespeare’s “Merchant of Venus”, the expansion and depression of the 1920s and 1930s, or even the present occupant of the White House.

Almost every sector in the commercial world has added debt as their currency for expansion. This is one reason to keep an eye on the slowdown in ROTCE (Return on Total Capital Employed). Bearing in mind that this sum does not cover accidents and supply chain issues adequately.

Please let me know what you think I can learn.

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

Mike Lipper's Blog: This Weekend’s Learning Sources - Weekly Blog # 939

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

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

Did someone forward you this blog?

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A. Michael Lipper, CFA

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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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A. Michael Lipper, CFA

Contact author for limited redistribution permission.