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Sunday with Michael Lipper

David R. Kotok
Mon Jun 7, 2021

Michael Lipper is an icon in financial market history. After all, he has an index named for him, and that’s the ultimate compliment among economists and financial market practitioners. Lipper is famous for his index on mutual funds and has a distinguished career in the investment management consulting and advising business. The Stevens Institute of Technology has recently named him to its board of trustees and in their announcement offers a synopsis of his auspicious career: “Stevens Institute of Technology Board of Trustees Elects Founder of Lipper Analytical Services, A. Michael Lipper,”  https://www.stevens.edu/news/stevens-institute-technology-board-trustees-elects-founder-lipper-analytical-services-michael-lipper. You can find follow Mike’s “Monday Morning Musings” at his blog (http://mikelipper.blogspot.com).

I recall a conversation with Mike in Cumberland’s conference room a few years ago. We were talking about some business matters, and then we digressed into the importance of written communication and how hard it is to continually write an interesting and provocative newsletter or commentary for clients or for the general public, as the case may be. That memory was jogged by Mike’s blog #683, “Dull Markets Are Dangerous for Investors,” which he published on Memorial Day this year. I emailed Mike and asked if he would give me permission to share it with our readers. Mike was kind enough to say yes and added the words “with pleasure.”

What I find in Mike’s letter is how thoughtful and provocative it is for an investor or the investor class and how timely it is in a period in which half the population of the broad financial-market investment world has no personal experience with interest rates other than those near zero or with the process that has taken place since the Great Financial Crisis. Of those who currently make up the entire array of investment professionals, approximately half learned about inflation or higher interest rates or other types of shocks from history books.

So with great respect and many thanks to Mike for permission to share this thought-provoking discussion, which captures strategic wisdom reflecting decades of experience, here’s Mike Lipper in blog number 683: http://mikelipper.blogspot.com/2021/05/mike-lippers-monday-morning-musings_30.html. We hope our readers will appreciate his message.

 
Dull Markets Are Dangerous for Investors — Weekly Blog # 683

Mike Lipper’s Monday Morning Musings

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

Why?

Not only because “quiet comes before the storm,” but dull markets give you the luxury of time for thinking and researching. Investors can use unhurried time to search for better investments and improve on the selection process, although most investors focus their energies on security selection. Some wise investors will ponder the processes used to manage their investment responsibilities, while commentators focus on the first group in the majority. As an investor for more than sixty years managing money for a limited number of investors and for my large family group, I am more concerned with the second need. Few pay enough attention to a periodic review of how we make decisions. Assuming you can make reasonable selection decisions, improving the decision processes will produce better results for the beneficiaries of your efforts in the long run.

Why Now?

Rarely can we assess in an unhurried fashion and review how we think about investing. We have such an opportunity right now. For at least the last six weeks the popular US stock market indices have been fluctuating within a trading range on relatively low and unconvincing volume. This is very logical if you believe equities are primarily priced on what they are expected to report in future periods, not what they have already reported. Expected future earnings are usually discounted at the current “riskless” interest rate of government bonds. Currently, many believe interest rates on US Treasury paper insufficiently discounts future inflation, pointing to the weakness in the valuation of the US dollar in multiple foreign exchange markets.

Others feel that after more than year of stock market gains it is time for a rest. Some point to the likelihood of not as favorable earnings comparisons after an expected large jump in the second quarter, especially when compared to the slow initial rebound in last year’s second quarter. Naturally, third and fourth quarter comparisons are expected to be more labored considering the 2020 recovery began picking up steam in the second half. (On the same basis, some believe earnings gains in 2022 will have tougher comparisons versus those in the coming quarters of 2021. Current spending plans for the rest of this year very much favor consumption with a lower investment value than productive capital expenditures.)

US stock markets are currently being held back by what one large US bank affiliated brokerage firm refers to as the 3 Rs = Rates, Regulation, and Redistribution. Some global investors, including those in the US, see foreign stock markets performing better than those in the US, as shown in the following table:

Stock Market Year-to-Date Gains

Canada          +20%
South Africa   +17%
France           +16%
U.K.                +15%
Taiwan           +15%

How to Improve Your Investment Processes

There are several ways to improve the various processes, unfortunately they require more work than the sound-bite/pundit driven world would suggest. Often, the best communicator is more of a commercial success than a better investor.

People like quick comparisons that lead to an ordinal ranking result, often leading to the identification of a leader at the peak of their performance. One of the more successful institutional investors, Marathon Asset Management, decries this approach in the following quote “categorization purposefully reduces complexity and nuances”. 

Nuances are critical to the understanding of comparisons; no critical analysis of peers is simple and straight forward. The following is a list of categories: stocks, bonds, growth, value, return on sales, operating earnings, earnings per share, book value, and tax rates. On a personal level, what about our significant others, or the schools we chose to attend. What is missing in these comparisons is the attention to quality, sustainability, integrity, personality, and the fit within the existing structure or portfolio. I suggest statistical comparisons do not provide answers, although they are useful in framing important questions exploring the answers to the “soft” questions.

Another critical technique is to not pay more than once for the same positive. For example, the chance of success for a company developing a new product or service creating new customers and opportunities is generally priced into the value of that stock. However, that premium should be eliminated once the product is on the market and operating earnings from the new product are counted in current earnings. R&D is critical for many large companies to maintain existing earnings power, it is therefore not worth an added value.

Turnarounds can be great investments, but the key is understanding if they can keep adding value in the future or are one-trick ponies. Proxy statements are useful in this analysis. After a new CEO has been in place for about five years, the degree of senior management and director turnover provides a clue as to whether the heavy work of the turnaround is complete or ongoing.

While I would be happy to discuss other analytical techniques with subscribers privately, I will include one final critical analysis for portfolio managers. How a considered investment modifies the existing portfolio and at what cost. A new investment will determine how the existing portfolio is modified and at what cost. Is the new investment going to reduce the chance of risk or add to performance in good periods? How much time will be needed to follow and deepen an understanding of the new investment? What is the appropriate starting position size and what are the likely points to augmenting the size over time? Are we comfortable with the other shareholders, both old and new?

Question of the Week:

Have you modified your investment thinking in 2021? If not, are you likely to make changes before year end?  

 

 

David R. Kotok
Chairman of the Board & Chief Investment Officer
Email | Bio


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