‘Things are rarely what they seem’ – Weekly Blog #718

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This is the title of a song by WS Gilbert from Gilbert & Sullivan in the operetta HMS apron. The title seems appropriate to think about investing today. In gathering research to reach my conclusion, I have excluded the positives that led to a bullish conclusion, but not because it is unlikely. On the contrary, most investors tend to be bullish and their views are documented by investment and political experts. Therefore, another similar voice is hardly additive. Seeing potential negatives is not a popular exercise, although it is useful for balancing one’s points of view. To be perfectly clear, the vast majority of my investments are in stocks and stock funds for the long term, even beyond my lifetime. I hope the majority will pay off in total return, comprised of price appreciation and growing dividends. The biggest problem today is that very few investments generate enough income to meet reasonable future expenses after inflation and taxes. The inability to meet current and future expenses related to dividend and interest payments is a sign of a high-priced market.

International Critics Competition

Our geopolitical discussions are often based on Ukraine or China, with these conflicts putting the Western world at a disadvantage, regardless of our greater wealth. The current administration plays checkers, where you have to get close to the opponent to eliminate one of the opponent’s pieces. The Russian leader seems to be an excellent chess player. The goal in chess is to capture the opposing king, using players who have different abilities and proximity. Our Chinese competitor believes that time is on its side and is building a greater level of self-sufficiency. Both appear to be capable executors of tactics and strategies based on a lifetime of hard work and success. By comparison, many of our cabinet members and senior executives were chosen based on their identity and political views.

Earlier this week, at an investment committee meeting, I mentioned that Russia had already accomplished its true mission, sponsoring disunity among European NATO members. German and, to a lesser extent, Italian business leaders wanted to maintain close relations with Russia and China. Although I still believe this is how they play world chess, there is counter action on the horizon. One of the main political parties in Sweden, concerned about the fluidity of Russian troop movements, wants to join NATO. With Sweden’s technological strength and good military, this could more than compensate for the potential loss of Ukraine. Whether or not this happens, the mere fact that this could be an example of “things are rarely what they seem”.

Guessing the future is hard

As securities analysts, we used to say that the only saving grace of weather forecasters is that they make us look good in comparison. (In terms of weather, I must point out that the less than optimal choice of date for the Allied landings in France was Ike’s correct judgment, which differed from the German military’s conclusion.)

Each year, the accuracy of the Congressional Budget Office’s (CBO) budget revenue projections is compared to its past record high. In fiscal year 2021, the projection was 15% too low, three times the normal error rate of 5%. Spending was 4% too high, double their normal failure rate. These projections were calculated after some mid-term corrections in March. The purpose of showing these misfires is another example of skilled statisticians falling under Mr. Gilbert’s song title.

I don’t have similar numbers for analyst misses in terms of sales and earnings for the same period. I guess the private sector’s error rate was equal to or higher than the CBO’s. My concern, especially for high P/E stocks with double-digit earnings multiples, is that errors can start to “be real numbers”. This can be especially true if one wants to invest for periods of ten years or more.

two different voices

This is the season when politicians and corporate executives tell us how good things are and will be with their fourth quarter and annual earnings announcements. Consumer and investor stocks are saying something different, with consumer spending in December slightly lower than in November. Consumers may have turned to holiday shopping earlier for fear of shortages, although a recent stroll through The Mall at Short Hills, a swanky mall, did not reveal any exuberant shoppers. This suggests that very little enterprise capital was used to increase capacity rather than fill the supply chain, although there was likely some inventory building on the industrial side.

In terms of net purchases of mutual fund and ETF stocks, they were dominated by the purchase of international funds and the redemption of domestic equity funds.

Opinions on a recession

Merrill Lynch market analysts believe the quickest path to a recession is a Wall Street crash. Jeremy Grantham, a manager who was precocious but correct, expressed a very dire view in an article entitled “Let The Wild Rumpus Begin”. He depicted an explosion of American extravagance, driving stocks, bonds, commodities and housing back to at least their base price levels. Barron’s headlined an article “The countdown to the next recession has already begun.” This article highlighted the Fed rate hike leading to a recession in 2024.

We can’t be protected from what we thought

Suppose we have a $1,000,000 portfolio invested 90% in stocks and 10% in long bonds. If any of the thoughts expressed above come to fruition and stocks and bonds fall at least 10%, you now have a portfolio of $900,000. While you continue to be hedged against a relative decline in one of the two asset classes, you are not hedged against the loss of $100,000. If you look at the purchasing power of your money, inflation and exchange rates could reduce the purchasing power of your investments.

Conclusion of work

Prepare for a tough market that will reset values, perhaps for a few years. At the same time, maintain long-term positions for future generations. They will need it, because the world may restructure in an unfavorable way, but at least they will have a start.

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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