The never-ending world of ‘new normals’: Lipper’s global outlook

Analysts love history, believing the future will be a repeat of the past. Almost every force for change today is itself changing. There is so much changing that there is a great temptation to retreat to cash or a central value index.

Quite probably, the least realistic and useful diagram for the future is a straight line. However, there are a series of mathematical manipulations that may be useful in identifying the multiple “New Normals” we will go through.

I believe it was in the second year of algebra that we were introduced to simultaneous equations. In these equations each formula has a different unknown, requiring each to be solved before completing the entire equation. There were other useful exercises that could also be helpful in our search for an investment strategy.

The first, which was mislabeled as geometry rather than logic, was proving theorems. In that exercise we segregated math formulas between those that supported the theorem and those that did not. The correct solutions were based on the logic displayed, not the number of pros and cons.

Perhaps the most useful math we learned was the math dealing with circles and semi-circles. I believe that learning to think in circular patterns is much more representative of the reality of human (market) behavior.

Where we are is more important than how far we’ve travelled

Utilizing the two-sided balance sheet approach, I will divide the current inputs between those I perceive as positive for long term investing in equities and stock funds vs. those that increase the risks of losing money.

Positives

In analyzing data we look for indicators that on balance successfully predict the future. Positive indicators are normally correct more than half the time. However, what is even more valuable are the rare negative indicators. On a contrarian basis they are correct more than 75% of the time.

  1. One of the best negative indicators is the sample survey of the American Association of Individual Investors (AAII). In the latest week, for the second week in a row, the survey is increasingly bearish, 48.9% and 47.8% respectively. A more normal three-part distribution has numbers in the thirties, as it was three weeks ago when it was 38.1%. Rarely do the weekly readings go over 40% and it is extremely rare for any choice to exceed 50% for the six-month outlook.
  2. Private clients at a large US brokerage firm bought equities for the first time in eleven weeks.
  3. Individual investors are not constantly wrong, although they tend to make up their minds slowly and consequently tend to be wrong at turning points. Data is no longer corrected on transactions below 100 shares, so we can no longer use the odd-lot theory. If we look at total flows, we see net purchases of $11.3 billion for fixed income securities and funds, including $2.6 billion going into TIPS and $5 billion net outflows from Equity. These flows are forcing the prices of fixed income products up and their yields down. This reflects market action and is not a predictor of future interest rates.
  4. We appear to be in two different markets at the same time. The daily stock price chart for the NASDAQ Composite is in an uptrend and has been establishing new highs. The other two main market index price charts look to be forming a temporary top, despite 24% of the S&P 500 being invested in FAANG stocks plus Microsoft. In 2013 the same stocks represented 9% of the index.
  5. Rising freight volume carried in trucks is expanding, leading to capacity expansion.

Negatives

  1. The Citigroup Panic/Euphoria Model is predicting a bearish period one year away.
  2. Investors are pouring money into fixed income, even though there is a long-term expectation for higher interest rates driven by inflation. One example of this is a repeated issue of a 100-year bond from Austria, a country without a particularly bullish outlook. A pitch used to sell very long bonds is that it avoids having to make more frequent decisions, which can be wrong!!!
  3. Some US investors are investing outside the US or the dollar. Of the 25 best performing mutual funds this week, 16 were precious metals funds (gold), 3 were emerging markets funds, 2 were China Region funds, 2 were India funds, and only 2 were invested in domestic small caps. Except for the precious metals group, the individual holdings in the other 9 funds appear more important that a sector bet.
  4. The VIX indicator of worry is selling at twice last year’s rate.
  5. Friday’s volume rose, which is not normal in the summer months, revealing interesting results that need to be further examined. The stock of T. Rowe Price lost 7.62% for the week, even though it published good results. On Friday, Janus Henderson had a market volume of 10.66 million shares, where the normal volume is 1-2 million shares.

Conclusions

We should not expect some clear straight-line news any time soon. That is not to say various pundits will not extoll these points of view, but on careful examination the precision of their views will come into question.

Despite what various political leaders state, we live in an increasingly integrated world and that is a net good thing, although it has a price, among other difficulties.

At today’s prices we are being paid to take long-term equity risk and are not being compensated similarly for fixed income risk taking.

We should focus on the announcement of capital expenditures in order to see how much is being invested in new products and new distribution, or see if it is being used to lower existing costs.

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.