Sound investment thinking should not be isolated into an island of investment and economic numbers. The powerful future trends are not found initially there.
The future is determined by people and how they think and occasionally react to what they feel about what they think they see.
On this Sunday we are between Friday’s worst stock market decline since 2016 and the most significant Professional Football championship. Both or neither could be guides to the 2018 investment future.
Friday’s stock markets actions
Depending on your personal favorite stock price measure, there was a low to middle digit percent decline was the beating headline. Far too many saw the fall as an automatic signal of potentially a much bigger slump.
As usual, too many did not look further into it to see the significance. To me, they missed three important inputs staring with the smallest and moving through to more major structural issues.
Warehouses provide pricey liquidity
Early in my investment career at a famous trust bank, I came across some large-cap stocks that were unlikely to be price performers that were in numerous otherwise reasonably sound portfolios.
The conservative investment still carrying the burden of the learned Depression experience were afraid in the 1960s that the then economic expansion would end with a substantial stock market decline.
They had learned the risks of premature market timing and opted to put a portion of their client’s trust money in stocks that would rise in some symphony with an expanding economy, but would fall less than the market when the turn came.
The classic warehouse stock was AT&T which had not changed its common stock dividend since 1922. In effect it became a bond substitute and rose when yields declined and grudgingly held most of their value when interest rates rose in a contraction.
The current AT&T is not the same company and today may or may not be attractive due to its relatively high yield and the prospective benefit of the forthcoming 5th generation of the internet.
The owners of warehouse stocks were not criticized when they cashed in these stocks and used the cash to cushion the portfolio decline and eventually use the cash to buy more aggressive stocks at cheaper prices.
What appears to have happened Friday was several handfuls of large cap stocks fell more than the general market excluding these stocks. Many of these stocks were dominant holdings in Large Cap Growth mutual funds and similar ETFs.
Numerous Mid and Small Caps fell much less. Is that due to the fact that they did not have a “warehouse function” on the way up or that their owners recognized that the trading capital in the market was unlikely to support significant sudden liquidation of the smaller brethren?
What I take away from Friday’s market action is a concern that there is not sufficient liquidity in today’s market to absorb easily a broad scale sell off.
Liz Ann Sonders/Minsky Moments explanations
Liz Ann Sonders, Charles Schwab leading market analyst points out that there is a history of years with low stock price volatility and are followed by higher ones.
As one of the better analysts on market sentiment and its limits, she points out that in the last three weeks in January the S&P500 went up over 7.5% and if annualized would have added 155% for the year.
Her caution parallels an earlier worry of the great Austrian economist who noted that periods of economic stability end with periods of instability. Bottom line: too much complacency can be dangerous to your wealth.
Supply/demand better analysis
All too often we make financial decisions based on numerical comparisons. Yet what we call judgment in many cases are human memories that our brains carry. For example, we tend to measure corporate success in terms of dollar revenues.
Many automobile manufacturers are showing record dollar revenues, but in terms of units sold or even more important, number of customers/ families served, the results are more discouraging.
The shift from two door sedans to five door SUV models hides these trends. The current enthusiasm for stocks is based importantly on better profit margins as taxes and burdens of excessive regulation are enlarging profitability. Most of the countries in the developed world have reached peak population except for immigration.
In the US we have one birth every eight seconds, one death every ten seconds. Including migration, we are adding one person every eighteen seconds. Global population is adding 4.3 births per second with deaths 1.8 per second which translates to 2.5 persons per second.
This suggests that the US population’s future economic growth is more likely to come from serving and being served by people in the Southern Hemisphere with particular focus on Africa and Southeast Asia.
While I can direct our clients’ investment policies to these geographical centers, until our society does we need to understand our loss of economic and financial ranking. What may make this task even more difficult for their own needs, government and central banks are attempting to manage inflation.
They have not been particularly successful. Apparently inflation is actually a derivative driven by currency and trade. These in turn are propelled by a combination of consumers and commercial interests.
Hopefully Friday’s action suggests to all of us that we are living in a changing world where the future is not going to be copied from our old experiences.
Super Bowl investment lessons
Perhaps it is particularly instructive to search for investment lessons from a championship that puts football teams from Boston and Philadelphia against each other.
While these two are no longer the largest or politically the most powerful cities in this country, they have contributed greatly to the formation of the US global financial community.
Boston due in part to being the home port for the ships that spent years trading with Asia developed a culture of trusted capital management.
Even today much of federal and other states’ law that directs much of the fiduciary principles that supervise the asset management industry. At one point there was more money managed by Boston law firms than the mutual fund business.
Philadelphia was not only the home of the Congress at the beginnings of the United States it also developed the key to capital equipment financing. Philadelphia lawyers created railroad equipment (boxcars) leasing certificates which created a global market for transportable assets and in turn supported the global market for mortgages.
For twenty years until I resigned, I advised on the management of the defined contribution plans for the National Football League and the NFL Players Association. From this experience, I believed that on any given day any team within the NFL could beat any other team.
Thus as of this Sunday afternoon I do not know which of these good teams will win. What I do know that the winner on a net basis will have the best combination of offense, defense, capitalizing on surprises, and leadership throughout their organization.
These are the very same characteristics that I look for in selecting fund management organizations for our clients. Other inputs for us today are an assessment as to consumer acceptance and politics as seen through the eyes of the media which will color some of our investment thinking as well.
I hope that we can draw appropriate conclusions from both Friday’s price actions as well as the Super Bowl; thus to be able to manage wisely the year ahead which is likely to be more difficult than 2017.
A former president of the New York Society for Security Analysts, he was president of Lipper Analytical Services Inc. the home of the global array of Lipper indexes, averages and performance analyses for mutual funds. His blog can be found here.