Mike Lipper’s Monday Morning Musings
Preparing
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018
Little did we know that nursery tales were preparing us to be sound
investors. Remember the story of the three little pigs who all built homes, but
only one survived the storms because he took the time to build with bricks.
Later, we grew up and found ourselves in a marching unit alert for the preparatory
command, immediately prior to an execution order. We should always have been
searching for preparatory signals to avoid major losses and unexpected gains.
Last week we warned that sudden rallies are usual in “bear markets”. Only time will tell if we have entered a bear market and if we should identify the following as preparatory signals. (What is your opinion?)
- Perhaps the soundest bank in Asia, DBS, was instructed by Singapore banking authorities to suspend various expansion efforts for 6 months.
- The leading banker in the US announced that he intended to sell roughly 12% of his ownership in the bank for estate and other reasons a year from now.
- In a private discussion, a CEO of a very successful private company bemoaned many companies for not being close enough to their customers to help guide them through the coming problems.
- Both Goldman Sachs and Morgan Stanley have reduced employment of talented people a couple times. A major large private investment organization has done the same.
- I went to an upscale department store looking for an appropriate business casual shirt in my size. The store only had small, medium, and large shirts, not the usual array of arm lengths or shirts with 2-inch variations. This brought home the statement by UPS that their package business from Hong Kong was down because retailers were reducing inventories.
- Panera just announced that is laying off 17% of their workers before they do an IPO. There has been an increase in mergers, but most of them are stock for stock deals. This is a sign that cash is too expensive, and their own stocks are no longer cheap.
Preparing Oneself
Marcus Ashworth is a brilliant columnist, which means that I agree with
him. He wrote “Probably the most underrated skill in finance is knowing when to
sell”. It may be wise to first identify what to sell. I suggest the first step
is to identify each holding in terms of purpose, as either speculation or
investment. The main difference between the two is whether your bet is based
mainly on the belief that the price will rise. Or alternatively that earnings will
grow, new products/strategies will be launched, new leadership will be in place,
or there will be a closing or a collapse of principal competitor.
The next step is to find or create an appropriate peer group. (This is
easier for mutual funds.) Then, in the shortest reasonable time-period, arrange
the peer group into quintiles. (Caution, avoid dividing the peer group into
quarters or halves.) If the peer group you are studying is a narrow-based
specialty, your best bet is to be in the top or bottom quintile. If it is in
the bottom quintile you are betting on the changing character of your
investment making it a winner. These types of securities normally do best for brief
periods.
I follow a different approach for diversified equity holdings. My approach
is less volatile than the general market and spends most of the time in the
second or third quintile. It is rarely in either of the extreme performance
quintiles. These placements are appropriate for long-term holdings with
periodic payments to beneficiaries and has the benefit of keeping clients happy
and maintaining relationships.
When to Sell
The biggest risk for many long-term investors is impatience, which was
noted by Blaise Pascal in the 1600s. He said, “All of humanity’s problems stem
from man’s inability to sit quietly in a room alone.” This sitting approach works
better with large portfolios of high-quality stocks, because over time the
gains will be greater than the losses, particularly during inflationary periods.
We are quite possibly not in such a period. Charlie Munger recently
commented that during Berkshire Hathaway’s (*) first four decades of Warren Buffet’s
ownership history it was relatively easy to pick sound investments. In looking
at the company’s 3rd quarter report there were a considerable number
of subsidiaries whose earnings were disappointing, but the success of their
larger positions more than made up for those that declined. (They have built up
a very sizeable cash reserve in anticipation of finding good future homes for
their acquisitions.)
* Owned in managed or personal accounts
Outlook(s)
The longer-term outlook is quite attractive, with IBES estimating S&P
500 earnings per share reaching $276.02 in 2025 compared to $218.09 in 2022.
The current concern about corralling the rate of inflation does not seem to be an
issue with 30-year US Treasury paper yielding 4.75%, not much different from
the 10-year rate of 4.56% and the 2-year rate of 4.83%. (I suspect that there
is considerable amount of leveraged buying of 2-year compared to the 30-year,
which is one of the reasons shorter rates are higher.)
However, the reason for discussing multiple outlooks is the shorter-term future looks more troubled than the longer. If one treats the period since the beginning of COVID-19 as a single unit, we have been going through stagflation with volatility. One of the reasons the stock market has done as well as it has is due to an increase in leverage, both operational and financial. Revenues have been going up marginally, but reported and adjusted earnings have risen by a multiple of sales. This resulted from an increase in private debt and other forms of debt extensions driven primarily by large caps. (In the latest week, declines represented 1% of the companies traded on the NYSE vs 23% on the NASDAQ). I previously alluded to the number of middle size companies owned by Berkshire not doing as well as in the past.
There were contradictory indicators delivered this week. On Saturday the
WSJ reported that 90% of the weekly prices of securities indices, commodities,
currencies, etc., were up. The sample survey of the American Association of
Individual Investors (AAII) had 50.3% bearish over the next 6 months vs. 24.3% that
were bullish. The bearish reading is not only twice the bullish, but entered an
extreme reading and was much larger than it has been over the last couple of
weeks. (It is possible that the sample skewed differently this week or
participants reacted to the news.)
My Operating
Conclusions Remain the Same
Some trouble ahead,
with better markets in 2025.
Did you miss my blog last week? Click
here to read.
Mike
Lipper's Blog: Indicators as Future Guides - Weekly Blog # 808
Mike
Lipper's Blog: Changing Steps - Weekly Blog # 807
Mike
Lipper's Blog: Change Expected - Weekly Blog # 806
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