AFMC - Current Market Portfolios And Ukraine - Weekly Blog # 779

2023-04-10 10:20:00 ET

Summary

• The assembly and management of investor money in portfolios is the real art of investing, not buying and selling individual securities.
• Each portfolio should have a narrow focus, often built around the timing and execution of the beneficiary’s needs.
• The biggest mistake most people make is measuring success based solely on the calendar year, because it’s what everyone else does. As the market moves up and down in its own periods, the measurement period should likewise be adjusted.

Current US Stock Market

The views and focus of pundits can be very misleading. Below is a list of some of them and my contrary thoughts for you to consider and react to. In no particular order:

1. The narrow performance premium of stocks over bonds is “ugly”. (To the contrary, it may be a good entry point. Over any reasonable investment period, one could envisage a 100-1000% gain for equities and/or equity funds. I doubt one could see that in bonds.)
2. The recent announcement of the number of people hired was “bullish”. (Within the release, there was the note stating that the number of hours worked declined. When business is bad, it is normal for a company to announce cuts in costs before a large layoff. This announcement was for a given middle week in April. At about the same time, the NFIB Small Business Hiring Plans Index announced a 15% decline for March (small businesses employ over half of working Americans). The NFIB also showed a widening gap in the number of hours worked between the rank and file employees and all others. This may show that businesses can’t find entry-level workers wanting to work. Another factor could be the better weather in March and April relative to the first two months. This suggests the rise reported for April was more weather-related than from improving business conditions.
3. Almost 90% of the first quarter’s gain came from just 20 stocks. UBS noted that if mega-cap growth stocks were deducted from the index, the remaining stocks would only have gained 1.4%. (New “bull markets” are not normally led by the leaders of the last up market. Currently, Large-Cap Growth funds are leading and Small-Cap Value funds are lagging - Tech vs. Financial Services.)
4. While the interest spread between two and ten-year Treasuries has narrowed very rapidly to 530 basis points from 1400 recently, it raises the question of whether the inversion is going to precede a significant recession. The weekly survey of the American Association of Individual Investors (AAII) is often considered a contrary measure by market analysts. In three weeks, the bearish prediction fell 13% points to 35%, with the bullish reading gaining 12% points to 33%. These numbers show how volatile the individual investor is, but it also shows that the bulls have not built a base for a higher market at this moment. (I disagree with the opinion of many professionals that the public is always wrong. I believe that they are mostly wrong at turning points but generally right over the long term.)
5. In a period like we are in now, the twin absence of trading capital in the hands of the former floor specialists and “upstairs” traders is having a significant impact on the security selection of investors. (Look at the declining average performance of mutual funds in the first quarter: Large-Cap Funds +6.71%, Multi-Cap Funds +5.11%, Mid-Cap Funds +1.78%, and Small-Cap Funds +0.50%. This rank order is the reverse leadership position of many past bull markets.)
6. The term “book value” should only be used by accountants, never in front of unsuspecting investors. Book value has nothing to do with either useful books or value. It is an accounting term to spread the remaining non-written off purchase price recorded on the balance sheet. It has nothing to do with the liquidating value of an asset, or what a knowledgeable unrelated person would pay for the asset. The present or future value of an asset might be of interest to a potential buyer if they are sufficiently discounted for the trouble and bother of actually receiving the assets and liquidating it.

Constructing Portfolios

With the exception of an entrepreneur singularly focused on a business that is close in value to the total of its assets, the assembly and management of investor money in portfolios is the real art of investing, not buying and selling individual securities.

Most individual investors and some institutions mechanically add and subtract securities from a portfolio. Most others have a single portfolio with some focus or general need. (I believe one should have multiple portfolios rather than just a collection of securities.) Each portfolio should have a narrow focus, often built around the timing and execution of the beneficiary’s needs. I use singular rather than plural terms, even if the timing and cost of the same security is different between accounts. (It could generate significant impact, and therefore, could be managed differently.)

The biggest mistake most people make is measuring success based solely on the calendar year, because it’s what everyone else does. (I believe accounts should be measured based on the first reasonable date assets will be paid out. There are also other issues to consider, such as the number and extent of down results compared to up results.) As the market moves up and down in its own periods, the measurement period should likewise be adjusted. To the extent possible, after-tax returns are preferable. If you buy the same security at different prices, each tranche should be measured separately, especially if the price is quite different. Buying a great security late in its rise rather than at the beginning impacts the results of beneficiaries. While the security may be the same, its intended purpose could be different.

I sit on a number of tax-exempt investment committees and try to get my fellow trustees to pick individual measurement periods. If a stream of payments is required for building a new facility, I suggest making the end date slightly before the first payment date, changing that date based on schedule. For annual operating funds, I use the same concept, but with much smaller time periods.

Finally, where possible I like to pick selected mutual funds having similar portfolio characteristics whose management sticks to policies that can responsibly be followed.

Ukraine is Just the Beginning, Not the End

We are all horrified by the cruel invasion of Ukraine. We wish the war would end, with the country’s full land being restored. Unfortunately, I believe we will be involved with Ukraine for many years, possibly generations. The unhappy reason for such a fearful statement comes to us from logistics management.

Just like Political “Science” courses, Securities Analysis is taught about the past and briefly hints at the present. One of the main tenants of sound business practice is building reasonable defenses against future problems. One of the largest potential problems facing businesses and countries can be summed up by the change of “Just in Time” production and delivery to “Just in Case”. Until very recently, businesses located the production of critical supplies where it was the cheapest to produce and where rapid transportation could ship goods and services to major customers.

The rise in tensions with China and some other locations has caused the US and others to review from where they will get their critical products and services. While China should not be ignored as either a source of goods or a market for sales, if either were drastically reduced or totally stopped, we would be in serious economic trouble. Currently, there is a mad dash to find supplemental sources of both production and sales. Other Asian countries are being examined, as are Mexico, other Latin American countries, and Africa, among others.

One very rich region I fully expect to play a role is Central Asia. This region contains Kazakhstan, Kyrgyz Republic, Tajikistan, Uzbekistan, and Turkmenistan. In addition to supplying the critical rail thruway for China’s “Belt and Road”, the region provides the new Silk Road to connect China’s vast population and resources to Western Europe. The region consists of 61 million people and 1.5 million square miles, with both Russia and China as neighbors.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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