It's Sunday evening before the Tuesday debt ceiling default deadline and index futures are up 1.4% on the prospect of a debt deal completing. For the time being it seems like we avoided catastrophe so I'll unwind my short positions throughout the week. I won't start however, until after it has passed the House (which has a handful of tea party fundamentalists) and could cause a last minute panic.
As of Friday evening, I had shorted ~12% of the portfolio using the SPY, while also hedging with August call options in the event that the market went up significantly on passing a debt deal. All in I'll likely lose under 1% on the position or ~0.1% for the portfolio just due to the premiums paid on the options and illiquidity of the option market.
That said, I also doubled my SWY bet to ~5% of the portfolio last week, so if it bounces a minimum of ~5% (which I think it easily can) the actions of the past week will all be awash.
I feel like I've gained two valuable lessons from this week:
The first is that I now have a better tool for heding the portfolio. If I'm concerned about a near-term sell-off or market turn down, I can take a hedged short position that has very limited downside risk (in this case ~0.2% to 1%). If I'm wrong, all I lose in the premium on the call options.
The second lesson is that while my bread and butter investing is from identifying and moving quickly on undervalued securities, if there's a significant macro-economic overhang nearly everything becomes correlated.
Disclosure: I'm short SPY and Long SWY.
Sunday, July 31, 2011
Wednesday, July 27, 2011
Groceries
Been watching SWY fall ~15% the last week on slightly lower guidance for the year.
This is just nonsense. There's no reason why the stock should have dropped this much.
I'm very tempted to increase my bet at current levels as I think it's ripe for a bounce. Is it worthwhile though if I'm only going to hold it for a 10% bounce? The stock should be worth at least $25-30 (barring a strike by the union).
Crazy. A grocery store with a ~13% P / FCF. People should take that deal any day, but I'm seriously hesitant to double-down due to the macro backdrop.
Disclosure: I own SWY.
This is just nonsense. There's no reason why the stock should have dropped this much.
I'm very tempted to increase my bet at current levels as I think it's ripe for a bounce. Is it worthwhile though if I'm only going to hold it for a 10% bounce? The stock should be worth at least $25-30 (barring a strike by the union).
Crazy. A grocery store with a ~13% P / FCF. People should take that deal any day, but I'm seriously hesitant to double-down due to the macro backdrop.
Disclosure: I own SWY.
Hrm. What to do?
Wow, it took until Wednesday for the market to show a little volatility on the debt ceiling overhang.
I'm not sure what to do.
I shorted some S&P (while buying some off-setting call options) earlier this week. The trade is now in the money, but it's only ~6% of the portfolio and I'm still sitting on a lot of cash.
Either way I don't see how the market's go up from here. Even if the default is resolved without a downgrade (which in itself should cause nearly all assets to reprice lower as you would need a higher discount rate) there's no way unemployment can go down with this type of uncertainty. One WSJ article indicated that GE was sitting on record cash balances (Bloomberg says $136bn) due to the macro uncertainties outstanding, including the U.S. debt ceiling. No company in their right mind will invest in labor or capital when the liquidity market itself is at risk!
Strategy
I guess my concern with scaling up the bet is how much can I really win?
If it's in a tax account all profits will be cut by 50% due to the short-term nature of the trade.
If it's in a tax free account I need to consider index inverse vehicles that have tracking error and may not function properly if the treasury market defaults. Who the hell knows, given that their value is based on derivatives with counter-party risk. And seriously, if the treasury market defaults, who isn't a counter party risk?
That said, I'd rather have my cash short the S&P (even if it's taxed at 50%) than in treasuries that only have downside (not getting any yield in the next 6 days).
Conclusion
I'm not a specialist at shorting the market. I'm a security analyst, not an index day trader. I'm only doing this to protect my capital. Once the ceiling is raised, which I hope it will, I will unwind these positions as my cash / money market funds will no longer be at risk. At which point, if I want to go short, I'll look for individual stocks or a basket of companies to short.
In a hypothetical default scenario, I would imagine that the most I would lose in the money market is 10-20%. I would expect the U.S. government to say that within days all the post-petition interest will be paid and old defaulted bonds will receive new bonds at 100 cent dollar face value.
This loss, however, due to the sheer illiquidity of the money market, would pale in comparison to how much the equity market and fixed income market will lose creating the opportunity for buying $0.50 dollars or even $0.25 dollars if I'm lucky (and assuming that the stock market is even open - which I doubt it would be).
This is a crazy range of scenarios, my stomach is upset just thinking about it.
I'm not sure what to do.
I shorted some S&P (while buying some off-setting call options) earlier this week. The trade is now in the money, but it's only ~6% of the portfolio and I'm still sitting on a lot of cash.
Either way I don't see how the market's go up from here. Even if the default is resolved without a downgrade (which in itself should cause nearly all assets to reprice lower as you would need a higher discount rate) there's no way unemployment can go down with this type of uncertainty. One WSJ article indicated that GE was sitting on record cash balances (Bloomberg says $136bn) due to the macro uncertainties outstanding, including the U.S. debt ceiling. No company in their right mind will invest in labor or capital when the liquidity market itself is at risk!
Strategy
I guess my concern with scaling up the bet is how much can I really win?
If it's in a tax account all profits will be cut by 50% due to the short-term nature of the trade.
If it's in a tax free account I need to consider index inverse vehicles that have tracking error and may not function properly if the treasury market defaults. Who the hell knows, given that their value is based on derivatives with counter-party risk. And seriously, if the treasury market defaults, who isn't a counter party risk?
That said, I'd rather have my cash short the S&P (even if it's taxed at 50%) than in treasuries that only have downside (not getting any yield in the next 6 days).
Conclusion
I'm not a specialist at shorting the market. I'm a security analyst, not an index day trader. I'm only doing this to protect my capital. Once the ceiling is raised, which I hope it will, I will unwind these positions as my cash / money market funds will no longer be at risk. At which point, if I want to go short, I'll look for individual stocks or a basket of companies to short.
In a hypothetical default scenario, I would imagine that the most I would lose in the money market is 10-20%. I would expect the U.S. government to say that within days all the post-petition interest will be paid and old defaulted bonds will receive new bonds at 100 cent dollar face value.
This loss, however, due to the sheer illiquidity of the money market, would pale in comparison to how much the equity market and fixed income market will lose creating the opportunity for buying $0.50 dollars or even $0.25 dollars if I'm lucky (and assuming that the stock market is even open - which I doubt it would be).
This is a crazy range of scenarios, my stomach is upset just thinking about it.
Saturday, July 23, 2011
Blows My Mind
Ron Paul, a Republican representative from Texas, published a piece this weekend titled the following: "Default Now, or Suffer a More Expensive Crisis Later."
It blows my mind that he 1.) equates a defacto default with a real default and 2.) he's will to risk a complete market meltdown / financial depression in the fear of inflation over time.
This is nuts.
Ron Paul link
Strategy
If they don't make progress over the weekend, I'm seriously considering taking all the cash I have (which is predominately in money market funds either holding treasuries or backed by government obligations - e.g. repurchase agreements collateralized by U.S. government obligations) and shorting the SPY (S&P ETF), while offsetting this with an equal amount of in-the-money, August call options.
If the tail risk plays out and the U.S. defaults, my money doesn't drop in value overnight (you really think Chinese treasury holders will not sell paper that is not paying them?). If anything, I stand the chance to actually make money if the S&P completely collapses. The call option would be worthless but the short position would make more.
If the tail risk doesn't play out and congress gets their act together, I lose on the premium of the call option, sell it, and cover my short.
Upside (if default & S&P declines 20%): 10-15%
Downside (no default / raise debt ceiling): negative 0.2-0.5%
From a probability weighted perspective, if the odds of default are greater than ~3% it's worthwhile to do the trade.
It blows my mind that he 1.) equates a defacto default with a real default and 2.) he's will to risk a complete market meltdown / financial depression in the fear of inflation over time.
This is nuts.
Ron Paul link
Strategy
If they don't make progress over the weekend, I'm seriously considering taking all the cash I have (which is predominately in money market funds either holding treasuries or backed by government obligations - e.g. repurchase agreements collateralized by U.S. government obligations) and shorting the SPY (S&P ETF), while offsetting this with an equal amount of in-the-money, August call options.
If the tail risk plays out and the U.S. defaults, my money doesn't drop in value overnight (you really think Chinese treasury holders will not sell paper that is not paying them?). If anything, I stand the chance to actually make money if the S&P completely collapses. The call option would be worthless but the short position would make more.
If the tail risk doesn't play out and congress gets their act together, I lose on the premium of the call option, sell it, and cover my short.
Upside (if default & S&P declines 20%): 10-15%
Downside (no default / raise debt ceiling): negative 0.2-0.5%
From a probability weighted perspective, if the odds of default are greater than ~3% it's worthwhile to do the trade.
Sunday, July 10, 2011
Sitting Out
I'm not an expert at making macro forecasts as it's easier to pick companies.
That said, as Ben Graham suggests, it's also important to understand the macro picture to allocate what portion of your portfolio should be invested in equities, cash and bonds.
At this time, I believe a maximum cash position should be achieved despite whatever near-term relative performance lag this may create vs. the major indices. I hold 70%+ cash.
The other 30% is complicated. My largest position is a Japanese basket of net nets (10%) and DCIX (6%) which I described earlier. My intention is to increase DCIX (ideally at a cheaper price) after they announce the completion of a new debt facility.
Data Points To Consider:
That said, as Ben Graham suggests, it's also important to understand the macro picture to allocate what portion of your portfolio should be invested in equities, cash and bonds.
At this time, I believe a maximum cash position should be achieved despite whatever near-term relative performance lag this may create vs. the major indices. I hold 70%+ cash.
The other 30% is complicated. My largest position is a Japanese basket of net nets (10%) and DCIX (6%) which I described earlier. My intention is to increase DCIX (ideally at a cheaper price) after they announce the completion of a new debt facility.
Data Points To Consider:
- A sovereign European debt default can cause a crisis in confidence in U.S. money market funds (a study by Fitch suggested the top 5 money market funds in the U.S. have 30-40% of their assets in European bank debt). This would not be an issue if the European banks didn't also own a lot of European sovereign debt. While the precise figures are unknown, it's easy to imagine a quick flight to cash, markets crash.
- Which makes this even more difficult is the fact that the U.S. is also having trouble arranging a deal to raise the debt ceiling, creating the potential risk of a U.S. default. I ultimately think this will pass without a major shock to the system, but it's a low probability event that needs to be considered.
- China slows down. Not sure when, but it looks like it could be now. And if it is now, very few investors are worrying about it to the degree that they should. Chinese investor psychology has all the marks of a bubble. For example, Caterpillar (CAT) is expecting to increase their excavator production by hundred's of % in the next 3 years. Is China construction development really going to increase multi-fold in the next few years b/c it's unlikely CAT is going to be dramatically stealing market share? I'd bet against it.
Sunday, July 3, 2011
Diana Containerships (DCIX)
Diana Containerships (DCIX)
Last Price: $7.07
Upside Target: $13
Summary:
Spun off from parent company DSX several months back. Management did an extremely dilutive secondary offering to expand container fleet by 150% and up to 250% (if they buy 5 more boats all in). As a result of the secondary, DCIX is down 50% from when it was spun off. DSX management spun off DCIX in an attempt to focus on container shipping which is expected to be much more profitable (less oversupply) than drybulk shipping in the coming years.
Thesis:
Last Price: $7.07
Upside Target: $13
Summary:
Spun off from parent company DSX several months back. Management did an extremely dilutive secondary offering to expand container fleet by 150% and up to 250% (if they buy 5 more boats all in). As a result of the secondary, DCIX is down 50% from when it was spun off. DSX management spun off DCIX in an attempt to focus on container shipping which is expected to be much more profitable (less oversupply) than drybulk shipping in the coming years.
Thesis:
- Will start paying an 8% dividend (annualized) starting in August with upside potential of a 12% estimated dividend if they establish a credit facility to buy two more boats.
- The stock will start to "screen" well in the coming months as DCIX gets onto people's radars.
- Comparable containership companies trade at 5-6% dividends which would imply 70-120% upside. DCIX also has a better balance sheet.
- Management bought $12mn of stock in the secondary offering at $7.50.
- I may be off slightly on the stats here, but the volume of containers shipped has only had 1 down year in the last 40. This was in 2009 when it was down HSD.
- When DSX initially went public it followed a very similar pattern. Issue more stock to buy more boats, stock drops nearly 50%, and then rockets higher.
- The secondary offering included an underwriters option to purchase more shares at $7.50 for a month. This expires during the 2nd week of July 2011 and will act as an overhang until then.
- Contract renewals in 2013 (shorter duration than comps) and who knows what will happen to shipping rates.
- Customer concentration (largely a circumstance of sale leaseback transactions with shipping companies)
- ~28% new boats coming online in the next 5 years (reflects low barriers to entry nature of the biz - but longer term as interest rates rise its less of a risk).
- Older boats (what they recently acquired) have a much higher daily operating cost (that may not be modeled correctly).
Value Grind Launch
In poker, the term "grinding" is used to explain the behavior of the poker player who sits for hours, folding countless hands in the pursuit of generating steady profits without going broke.
Value investing is in many ways like grinding. Success comes from endless hours of filtering through ideas, discarding most, and only in the face of bold irrationality or mass hysteria, do scalable opportunities present themselves. In these moments, investors who act promptly in scale can experience disproportionate returns on the risk assumed.
This journal chronicles my journey on the Value Grind.
Any opinion expressed in this journal is solely my own, and you should not treat any opinion expressed on this site as a specific inducement to make a particular investment.
Value investing is in many ways like grinding. Success comes from endless hours of filtering through ideas, discarding most, and only in the face of bold irrationality or mass hysteria, do scalable opportunities present themselves. In these moments, investors who act promptly in scale can experience disproportionate returns on the risk assumed.
This journal chronicles my journey on the Value Grind.
Any opinion expressed in this journal is solely my own, and you should not treat any opinion expressed on this site as a specific inducement to make a particular investment.
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