Wednesday, January 18, 2012

Where we are...

I'm getting aggravated by this market again.  Not a lot of great opportunities offset by what I perceive as perilous macro environment. It really is a time to stick to my guns, and just focus on learning.

So far my performance this year has actually been very good. Up 2%, while I'm only running 5.5% net exposure. In other words, I've kept up with half of the S&P's move (up 4% YTD) while being 94.5% not invested.

Saturday, December 3, 2011

Kyle Bass and the Coming Global Forest Fire

I believe that if you are a citizen anywhere in the world, this is probably the most important video that you could watch this year. Yes, the interviewer with his twirling glasses is full-of himself and really annoying, but Kyle Bass makes up for it with his genius.

 Kyle Bass Interview

Understand Long Term Valuations and Expectations

The chart you see here I original saw from the website

While I'm not going to walk through the details of the calculations, I'll summarize the conclusion: The red-line looks at 15-year returns following a given year. Hence the reason why the red-line stops in the mid-90's (It's nearly 2012, so 15 years ago ~1997). So you can see that the market since 1997 has returned about a ~4% annual return (technically ~3.66% per annum from November '07 to November '11).

The blue line, shows what the 15-year returns would have been forecasted at any given date by looking at a 10-year average multiple for the S&P, inverting it (so 20x 10-year average is a 5% return) and making some adjustments for inflation.

As you can see, over a long period of time, the returns of the market over any given 15-year period, haven't deviated too far from what a 10-year valuation would imply. This seems logical enough. After all, if you pay too much for an asset, the returns will be lower, and if you find a bargain, your returns should be higher.

The current market environment implies that over the next 15-years, the total return will likely come between -2% per year to +2% per year.

Yet another clue that after a market rally like this past week, it's good to sit on cash and wait for dramatic bargains.  It's just a matter of waiting. If the market continues to rally, the 15-year forecast will likely go negative, in which case I'll consider increasing my 13% S&P short position.


Just as a follow up to this post. Let's say the above forecast is correct (as it has been roughly for the past several decades) and the market is set to compound at -2% to 2% per annum over the next 15-years (technically its closer to zero but let's put a range on it). If we want to assume the optimistic scenario, the upper range, we use 2% per year. This implies that the S&P can increase by about ~35% over the next 15 years, from ~1,244 to ~1,674.

This really helps justify my big S&P short position. There are all these huge macro risks that can tank the market in the coming months and if none of them play out, in all likelihood, the most I'll lose on my short is ~35% over 15 years. In contrast, all the stocks I own can compound at 8%+ per year (through shareholder returns and growth), and I think could easily increase by 50-100% in the next 3-5 years (barring a macro collapse). Feels like a the right set up, but at the same time, I don't want too much net exposure (aka if I buy a stock, I'll offset the equity exposure by shorting the S&P). 

Wednesday, November 30, 2011

Santa Rally Follow Up

The market was up 4% today.

Below is a link to an article explaining why (China lower rates, coordination with multiple central banks lowering the rate on funds that are borrowed during emergencies).

Forbes Article

I thought about covering my 13% S&P short at the open, but decided to hold on for a few reasons: 1.) this seems like an act of desperation (they're lowering the emergency overnight rate, because they don't have any other policy options left) and 2.) the structural problems in Europe are unaddressed.

My friend Steve described it as laying foam on the run-way ahead of a plane crash. I like the analogy.

In the mean time, I'm trying to live the value life style: Look at stocks that I think have deeply compelling business models that will prosper for the next 20-30 years and make a list waiting for them to come down to attractive prices.

There's a reason that so many value investors live and work to past their 70's. It's because the lifestyle is much easier. It's not as stressful. You sit on your ass and enjoy the day reading about great businesses. All the while you wait for good opportunities. If there's no good opportunities today, go home earlier and read about something fun. At most, maybe you get a couple of opportunities a year.

What a great model.

Sunday, November 27, 2011

Thanksgiving 2011

Bloomberg had an article on how the S&P had its worst Thanksgiving week since 1932, the Depression.

S&P Worst Week Since '32

Before going into my strategy for the rest of this year, I need to acknowledge that my call for a market crash in October was dramatically wrong and reflects my inability to call the market. Instead the market sharply rallied and my hedges cost me a lot of money. For a brief period my performance looked particularly lackluster as the broad indices were positive for the year, while I was still down ~1-2%. Since the October rally, I exchanged my stock specific hedges for an S&P short that I don't have to roll-over each month and pay the option premiums.

While my views of the market are below, my strategy remains largely the same: sit on cash until you find great businesses at good prices. There are a few that I've come across over the past few weeks, but nothing that I've bought in size as I'm still waiting for a broad market capitulation in the coming months or years.

I'm planning on two separate outcomes for the remaining of the year:

1.) Usually this time of year there is a Christmas / Santa Rally. It's bonus season and it helps put Mr. Market in the mood for the season's cheer. That said, with the S&P down ~8% YTD and layoffs announced in the thousands it's hard to see a strong rally. Perhaps it could come from a delusional life-line that the ECB will save Europe.  It wouldn't be the first time the market went up on a hope and a prayer, just look at October this year.

This view is already partially confirmed as I look at my Bloomberg -- U.S. futures indicate a strong market opening on Monday morning "amid speculation the International Monetary Fund will help Italy after the nation's borrowing costs surged." Its funny how the short-term "fixes" that neglect the structural problems can still get the market's animal spirits going. It was only a few weeks ago in October that the market was surging on France's "ultimate solution" and only a few months ago where many said "there's no such thing as a new normal."

If we do get a broad market rally I will likely take it as an opportunity to unload some of my less favored positions like TSRA, SWY, and the remainder of my Japanese basket. The goal would be to free up some cash for better opportunities in the future. Maybe I'll even consider adding to my S&P short. I currently have ~20% gross long exposure, ~7% net.

2.) If the market continues to sell-off I'll probably just sit tight. Human nature being what it is (you can debate on whether its optimistic or predictably stupid), I view this scenario as less likely. Given my low net exposure, I'm happy sitting tight. Maybe I'll even consider some small purchases or locking in some profits on my S&P short depending on how far the market drops. I expect the market will ultimately breach its September / October lows, but we may have to wait until 2012-2013.

Overall I still view the economic landscape as a mine field where any day in the future you can wake up to discover the market is down 5%+ on a major "surprise" headline: "Greece Defaults", "Italian Debt at 10%", "Israel Strikes Iran Nuclear Facilities - Oil Price Shock", "Japanese / French / U.S. Debt Downgraded","Major European Bank Run", etc.

These are perilous times and I think the right play is from the story of "Farmer Womack."  Sitting on mostly cash and waiting for the moment when everyone else is depressed and has little hope of the future. Then you buy.

Wednesday, October 19, 2011

Best Summary of the Recession Risk I've read

Recession Summary from Kelpie Capital

What a fantastic summary.

The only thing missing is the list of over-leveraged banks in Europe that Hussman included in his most recent weekly write-up.  Found here.

Tuesday, October 18, 2011

Another Day in the Grind

I currently have a ~8% short against the S&P and another 6% of the portfolio is in puts that offset long-positions (CA / SWY / WFC). My net exposure is 4%.

Holding my shorts / hedges are brutal. They've been wearing on me and I've been sleeping less. My wife says I'm not stressed, just tense. And of course, she's right.

I've been trying (poorly) to trade the S&P short, but I think I may be falling into the pot committed stage where I just push my S&P short and hold it. How much higher does the market go on speculation of an all encompassing European solution?

Just look at how this crisis has evolved. Greece was the focus. Now the focus is on saving the banks because, whoops, it's very likely that Greece will default. So then the European regulators run some bank tests and say all banks are fine with Dexia at the top of the list for clean health. Then, whoops, a few weeks later, Belgium and France race to save Dexia. 

The world I look at (not my personal world, but the world at large) is filled with unhappy people, high unemployment, a government looking to tighten its belt (U.S.), and an entire continent with a financial bomb waiting to implode (Europe). This is depressing, so I short and I'd like to gain from when the market eventually implode.

I'm only down 1.7% YTD, but gosh, waiting for the next great time to swing for the fences is a grind.