2 Cycles Are Worth Watching – Weekly Blog # 793

Concept

I am basically a student. My reading of history, politics, government, finance, and sports reveals that each trend reverses somewhat before following a different trend.

In selecting individual securities, the specific characteristics are often of primary importance. In constructing a managed portfolio, the analysis of sectors are important. In deciding whether or not to invest, cycles may be the most important factor. All of these considerations need to be adjusted for the identified needs of the owner of the asset. As an investment adviser, I must consider these different responsibilities.

Below is a review of history through different cycles, along with a view of both the current period and various potential phases.

First Investment Cycle

In some respects, an investment advisor is like a baseball umpire behind home plate calling balls and strikes. A famous umpire once stated that he calls them as he sees them. As an umpire, I call them the same way. The difference is that my initial view utilizes mutual fund data. Not necessarily the best investment research media for all accounts in all situations, but a superior one for relatively unbiased analysis. Other measures rely either on a small group of expert analysts, media employees, or choosing to be listed in a specific marketplace.

Unlike the alternatives, mutual funds have in or out cash flows every market day and reflect the periodic decisions of their managers. Since there are more than 15,000 funds, this represents a large number of decision makers. Their results are much quicker at picking up the impact of investor decisions. (My old firm’s data is now published by the London Stock Exchange Group, which purchased it from a subsidiary of Thomson Reuters after it acquired it from me.)

Each week, I review 107 mutual fund peer groups over 11 time periods. This week, I focused on the total investment return in three time periods: the 5- and 10-year periods and the period since the trough on 3/23/2020 through 7/13/2023 shown below:

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Observations:

1. Large-Caps won the last 5 years, but not the recovery.
2. Small-Caps were the recovery winner.
3. Mid-Caps with value orientation could be a reasonable bet, probably benefiting from M&A.

While “the market” is focused on reported inflation, consumers are not. Using the experience of retail consumers during Amazon Prime Days, the average order was $54.05, up only 3% from last year. A significant increase in “Buy Now, Pay Later” shows that consumers are managing their cash carefully.

According to a recent survey, 40% of asset owners are considering indexing. Equal-weighting is gathering attention, a positive initial change that perhaps leads to active management later. The more investors congregate in the center, the less buying competition for attractive securities. However, for the best-selling opportunities, buyers will have to wait until the too-easy choice of the center becomes lonely.

Analytical Conclusion

The current large-cap, growth leadership is unlikely to lead competitive investors much longer.

Despite the media hype that we are in a new “bull market”, investors for the most part are considering other issues. Top and bottom prices are established in the market, not through highs and lows in a calendar year. Using historical peak prices, the DJIA is 6.63% below peak, the S&P 500 is down 6.46%, and the NASDAQ is off its top price by 13.77%. We have therefore not been in a bull market. One can view what we have experienced as a rally or a correction. The NASDAQ Composite, the best-performing index, hit its high on 11/19/2021. On that basis, we have been in a “bear market” with rallies for almost 2 years. This could be the first part of the feared stagflation, which could last for many more years, using history as a guide.

The Major Empire Cycle

One oversight of our Western European-focused education system is not studying the repeated failures of various empire cultures around the world, not only in government but in business too. These problems could be avoided.

World trade is often the litmus-test relative strength evidence of growing and declining empires. We are entering the test period now. The World Bank noted that China contributed one-half of annual world growth over the past few years. Due to current disinflation and deflation readings from China, it is expected to contribute only one0third of the reduced size of world growth this year. This weekend, The Wall Street Journal had a front-page headline stating “China’s Slowing Growth Has Many There ‘Losing Faith’”.

Instead of the US taking a victory lap, we should be concerned. The math of the situation is that China’s import of US goods and services is dependent on their dollar earnings from Chinese exports. This is on top of Washington’s vote buying efforts restricting risk-oriented investment into the US. Odds are, a top-down Washington-directed industrial policy is unlikely to produce positive results quickly.

One of the lessons I learned from college fencing was to respect my opponent and his abilities, including some that were not obvious. I feel the same way about China. Even though I have visited Beijing (central government), Shanghai (commercial power), and Shenzhen (industrial development) over the years, I also spent additional time in Hong Kong, where we had an office before HK was returned to China. I do not claim to understand how China really works. It, however, has one of the longest written histories of any large society, so I know it does work.

China has had some form of central government for at least 3000 years. Only rarely has it been ruled by an invader. Most of the time, it has been ruled by a succession of dynastic families. Failing dynasties have periodically been replaced by palace revolts or revolutions from the south. During this long period, it has been the leading country of the world at times, as well as its scientific leader. At one point, it had the most powerful navy in the Mediterranean, before recalling it to be burnt due to politicians at the court not wanting any foreign entanglements.

There are two reasons for mentioning this. The first is to acknowledge the world power potential China could have had. The second is to demonstrate that China has always had an isolationist stance. Roughly 90% of its inhabitants are classified as Han Chinese today. Many other ethnic groups within their borders are carefully monitored. The largest being the 3 million Uyghurs and other Muslims which arrived before Marco Polo.

During the Song Dynasty (960-1279), there was a great deal of scientific advancement. This advancement was probably based on algebra, which the Chinese invented. Arab traders later used algebra and introduced it into the Muslim and European cultures. Other inventions from China were the abacus, gunpowder, binary code (genetic sequencing), paper making, and printing.

The basic unit in Chinese culture is the family. Families are often grouped into Tongs, some of which have led to dynasties. Loyalty stretched from the family unit up to the courts of the leaders. Most of these units had a singular leader, generally the most powerful man and only rarely a woman. Even today, most groups are led by a dominant male.

The present leadership views its power as being derived from providing jobs, housing, and food for its citizens. At the moment, there are no known potential rivalries for leadership. However, those on top are undoubtedly concerned about the large number of youths between 16 and 25 without jobs. They are not accepting low-level jobs below their educational expectations. There is two-way traffic for young, smart people. Most move to Western countries, preferably the US, when given the chance. However, there are a small minority working in the US who experience bias against them and return home, where they are welcomed.

Housing is another problem. While a lot of apartment building have been initiated, many are incomplete because builders spent the deposit money on marketing and other unfortunate expenses. The government, mostly through the provincial governments, is trying to help, but progress appears to be slow.

Two Conclusions

1. China is having recognized economic difficulties. However, their disappointing 5% goal for this year is many times larger than the somewhat rigged 1-2% growth in the US and no growth in Europe.
2. China in the long run has some built in advantages, such as the Central Asian railroad into Europe which is being built to sell their improving quality goods. Their second big advantage that has become clear to the world is the poor-quality US government leadership, stretching from Afghanistan through Taiwan and into Ukraine. While China is having growing pains, the US is retreating.

Under these circumstances, it is probably prudent to include some Chinese assets for global diversification as an important hedge against our problems here.

Original Post

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