I've been reviewing Wells Fargo (WFC) recently as interesting prospective investment (hence the housing analysis yesterday). One of the tables they provide is listed below,which I think reflects the current issue with the U.S. economy. In summary companies have improved but the consumer is still only marginally better.
This is a table of their nonaccrual loans (aka when performance of a loan is not "reasonably assured"). As you can see the consumer nonaccrual loan book has only declined ~12% y/y while commercial has declined by ~25%.
Sunday, August 28, 2011
Saturday, August 27, 2011
Housing Voodoo
A number of months ago my wife and I checked out a condo for sale near where we lived. Not surprisingly the sales woman not only indicated that it was a "good buy" but that housing prices were likely to recover soon. It was a strange moment for me because I realized at that point I had no idea what housing prices were going to do and more importantly I had heard this before.
It's funny how everyone I know who has shared their two cents on home prices have always employed the same logic: well its gone down so much it's gotta go up soon! But is it really? Gamblers fallacy?
So while I'm no economist, I'm tired of hearing everyone's opinion and wanted to check what the numbers would suggest. Earlier today I came across data from the Census Bureau that shows household income in 2009 dollars going back to 1991 and home prices across the U.S. provided by the Federal Housing Finance Agency over the same period. Now I'm sure there's multiple different types of data to use that shows other perspectives, but this is what was available to me on my quick search.
The data suggests the following story. From 1991 to 2001 household prices gradually increased with household income. I guess this makes sense all else being equal. If everyone makes more money, everyone is going to pay a little more for their home. What's a little surprising is that home prices actually grew slower than household income during this period.
But then, as some would suggest (and I tend to agree), the tech bubble popped and the Federal Reserve lowered interest rates due to fears of a prolonged and deep recession. This in turn encouraged both more lending and lower loan standards. You can see this as home prices dramatically overshot the growth in household income from 2002 and ultimately peaked during the 2H'06 / 1H'07.
Since then U.S. home prices are down ~35-40% through 1H'11. While I don't have the household income data for 2010 and 2011 I'd seriously doubt that it's increased significantly since 2009 which means between 1991 to 2011 home prices AND household income have increased about the same ~75-80%.
I think this is significant because it means that the price declines of the last few years have only wiped away the excess home price growth that occurred from 2002 to 2007. If home prices were indeed depressed, wouldn't they decline relative to household income?
Conclusion - Where to from Here?
So based on this data I think its actually far from certain that home prices should bounce from here. I'm not saying they're going to collapse, but I honestly think up OR down is possible.
After all, if home prices could overshoot on the upside (relative to income growth) why can't they undershoot? Couldn't a weak economy, more cautious lenders, and potential overhang of foreclosed properties result in a truly depressed housing market in the future?
It's funny how everyone I know who has shared their two cents on home prices have always employed the same logic: well its gone down so much it's gotta go up soon! But is it really? Gamblers fallacy?
So while I'm no economist, I'm tired of hearing everyone's opinion and wanted to check what the numbers would suggest. Earlier today I came across data from the Census Bureau that shows household income in 2009 dollars going back to 1991 and home prices across the U.S. provided by the Federal Housing Finance Agency over the same period. Now I'm sure there's multiple different types of data to use that shows other perspectives, but this is what was available to me on my quick search.
The data suggests the following story. From 1991 to 2001 household prices gradually increased with household income. I guess this makes sense all else being equal. If everyone makes more money, everyone is going to pay a little more for their home. What's a little surprising is that home prices actually grew slower than household income during this period.
But then, as some would suggest (and I tend to agree), the tech bubble popped and the Federal Reserve lowered interest rates due to fears of a prolonged and deep recession. This in turn encouraged both more lending and lower loan standards. You can see this as home prices dramatically overshot the growth in household income from 2002 and ultimately peaked during the 2H'06 / 1H'07.
Since then U.S. home prices are down ~35-40% through 1H'11. While I don't have the household income data for 2010 and 2011 I'd seriously doubt that it's increased significantly since 2009 which means between 1991 to 2011 home prices AND household income have increased about the same ~75-80%.
I think this is significant because it means that the price declines of the last few years have only wiped away the excess home price growth that occurred from 2002 to 2007. If home prices were indeed depressed, wouldn't they decline relative to household income?
Conclusion - Where to from Here?
So based on this data I think its actually far from certain that home prices should bounce from here. I'm not saying they're going to collapse, but I honestly think up OR down is possible.
After all, if home prices could overshoot on the upside (relative to income growth) why can't they undershoot? Couldn't a weak economy, more cautious lenders, and potential overhang of foreclosed properties result in a truly depressed housing market in the future?
Increased Uncertainty Requires Increased Discipline
It's also worth remembering that in an economic environment of increased uncertainty, I must have increased discipline with investment purchases. My target is to buy fifty cent dollars and scale up if they fall to thirty cent dollars.
After all, it's more painful to reach for a a sixty cent dollar that falls to thirty cents, then it is to miss on the opportunity that a sixty cent dollar goes up 80%.
Or as WEB would say, it's better to make a mistake of omission than commission.
After all, it's more painful to reach for a a sixty cent dollar that falls to thirty cents, then it is to miss on the opportunity that a sixty cent dollar goes up 80%.
Or as WEB would say, it's better to make a mistake of omission than commission.
Friday, August 26, 2011
Economic Improvement or Double Dip? Strategy for Volatility
I'm clueless as to where the market is going from here. Continued economic improvement, or double dip recession? Clearly the market isn't sure either given that it dropped 2% after Bernanke said today he's not pursuing QE3 just yet but nevertheless the market still proceeded to bounce and then rally to end the day positive ~1.5%. Why all the crazy volatility?
Empathizing with the Enemy
There's a phrase about how Wall Street analysts know the price of everything but the value of nothing. In a sense, that is this environment. People are scared out of their willies on the concern that we're going into a double dip. If this happens, everything should be fundamentally worth less (not "worthless") because economic conditions are worse. In which case, don't buy anything, because you'll be able to buy everything cheaper in the coming months.
On the flip side, what if the recent sell-off was just a function of political dysfunction and a ratings downgrade? If that's the case, and the economy is actually fine, shouldn't the stock market rebound to its previous high? If this plays out and you are a hedge fund manager sitting on the side with lots of cash, you're going to look really dumb given that you're now under-performing the market!
So if you bet, and the economy tanks, well, hopefully you lose less than everyone else and investors don't redeem too much of your assets under management. If you don't bet, and the market rallies you face career risk. This reflects the unpleasant set of circumstances for most money managers and I think is the heart of why the market can have such volatile intraday price movements. The market is skittish, because the investors are!
Strategy
My strategy is a bit odd, stressful and more time consuming than usual but it works for me (so far). I'm currently tracking my largest positions and if I notice that the price action starts moving against me, I'll completely hedge my bet with put options. This of course limits my near-term upside if they have 1 or 2 days of favorable gains, but I think it's worth it if a double dip does happen. After all, rule #1 is NOT that you have to make as much money as possible. Rule #1 is "Don't Lose Money."
Despite this focus on preserving capital, I'm currently down about ~2.5% vs. -5% for the S&P and negative 11% for the Russell.
Bargain Bin?
I don't see an overwhelming list of companies that strike me as dirt cheap bargains, so I'm not really expecting to vary dramatically from 20-40% invested. That said I currently only have 20% net exposure as I shorted the S&P yesterday (5% that I'll probably unwind Monday if the market continues to show strength) and I completely hedged my SWY this morning (another ~5% of the portfolio). Both hedges lost me money today, so it's a painful strategy, but I think it's the right one.
Thursday, August 18, 2011
S&P Down 4% (So far today)
The last few days I've spent pairing back my positions. I sold a small stake in RIMM (10% loss), brought down my Japan basket to only 2.4% of the portfolio (from 10% earlier this year) and I 100% hedged out my position in CA with put options.
So net of these actions, I'm only ~20% long. YTD I'm down nearly 3%. Not great, but better than the S&P down ~8%, and the Russel 2000 down 13.5%.
I spoke with a small hedge fund manager based in OC yesterday who is buying on this dip. I think it is the wrong move as valuation still leaves a lot of room to the downside. It's important to recognize that investing is not just psychology (buying when others are fearful), but also when things are dirt cheap.
So net of these actions, I'm only ~20% long. YTD I'm down nearly 3%. Not great, but better than the S&P down ~8%, and the Russel 2000 down 13.5%.
I spoke with a small hedge fund manager based in OC yesterday who is buying on this dip. I think it is the wrong move as valuation still leaves a lot of room to the downside. It's important to recognize that investing is not just psychology (buying when others are fearful), but also when things are dirt cheap.
Monday, August 8, 2011
S&P Down 6.66% (Down 17% Since 7/22/11)
The experience with DCIX (now ~9% of the portfolio at cost) has also made me consider a new rule. In up markets, I need to scale up positions faster, but in down markets, I should scale up slower. In short, adjust for the environment. In down markets, you will always be surprised at how cheap things may get.
I think the experience with DCIX also reinforces the importance of holding lots of cash in periods of mediocre to lofty valuations. Even though this was my largest position and it declined 30% in my face, I'm only down ~3.3% YTD (vs. -11% for the S&P and -17% for the Russell 2000) because of the cash position.
Strategy
Despite the dramatic move in the markets, the opportunities I've seen are still by and large mediocre. That said I expect a near-term bounce as rarely do securities go straight from overvalued to cheap in just a few weeks. Like many hedge fund managers, I would take any relief rally as an opportunity to unload any positions I'm not happy with, and to increase my short positions.
Remember the environment. Any new positions should start off as 3-4% of the portfolio and then scale up to 10% as it gets even cheaper.
I think the experience with DCIX also reinforces the importance of holding lots of cash in periods of mediocre to lofty valuations. Even though this was my largest position and it declined 30% in my face, I'm only down ~3.3% YTD (vs. -11% for the S&P and -17% for the Russell 2000) because of the cash position.
Strategy
Despite the dramatic move in the markets, the opportunities I've seen are still by and large mediocre. That said I expect a near-term bounce as rarely do securities go straight from overvalued to cheap in just a few weeks. Like many hedge fund managers, I would take any relief rally as an opportunity to unload any positions I'm not happy with, and to increase my short positions.
Remember the environment. Any new positions should start off as 3-4% of the portfolio and then scale up to 10% as it gets even cheaper.
Saturday, August 6, 2011
What I Need to Remember
If the economy truly double dips, the markets will be in a period of pain for a long and protracted period. Extreme opportunities will be available for weeks, months and potentially years.
Conclusion
Don't rush my analysis. Look at one company at a time. Stay focused. Don't let the emotions of others or the environment rush my decisions.
Strategy
My strategy is to find great companies at 10-15% free cash flow yields. If it goes to 15-25% yields, then make it 10% of the portfolio.
In the mean time, I'll keep 1-bazooka shot (~15% of the portfolio) available to buy a basket of goods when the market ultimately capitulates.
In the mean time I sit waiting with 70-80% cash (slightly higher as I've started liquidating the Japan basket).
Conclusion
Don't rush my analysis. Look at one company at a time. Stay focused. Don't let the emotions of others or the environment rush my decisions.
Strategy
My strategy is to find great companies at 10-15% free cash flow yields. If it goes to 15-25% yields, then make it 10% of the portfolio.
In the mean time, I'll keep 1-bazooka shot (~15% of the portfolio) available to buy a basket of goods when the market ultimately capitulates.
In the mean time I sit waiting with 70-80% cash (slightly higher as I've started liquidating the Japan basket).
DCIX Follow Up - $5.09
DCIX is causing a lot of short-term pain and is one of the primary drivers why I'm down ~2%+ so far this year. Unfortunately I made it a 8% portfolio position before it sold off ~30% in the last week. I had incorrectly assessed that investors would start to wake up to the dividend potential with their 2Q'11 results as I though management would consider laying out in detail how much of a dividend they could start paying out next year. At a minimum, I think they start paying out $0.50 next year or a ~10% yield.
DCIX Story:
So take the market cap and subtract their net cash and your paying $74mn for boats marked at $161mn. A 55% discount to their purchase price after depreciation.
The Fear (putting logic behind the sell-off other than the idea it may have just been a big seller who was desperate to sell)
The reason why the stock has sold off is because there's a general fear that the global economy is about to collapse, leading global shipping rates to collapse. If this happens then will DCIX really be able to pay a dividend when they recharter their boats in 2013? Probably not. But will they go bankrupt, nope.
My conclusion is that even if charter rates collapse to a level that is unprofitable for DCIX through 2013 (which keep in mind would be a hell of a recession / depression) their annual operating expense is ~$4mn. They could burn cash or liquidate boats to hold them over for when rates improve. When they do, you'll ultimately be sitting on an asset that if purchased at current prices will start paying you at least a 10% dividend.
Conclusion
I consider this sell-off a good reflection of the volatility and opportunity in small cap stocks. All it takes is a few large sellers to crush the stock. That said, I think anyone who buys right now and can stomach the volatility, will be in the money.
Disclosure: I own DCIX.
DCIX Story:
- At $5.09, DCIX has a $117mn market cap.
- They have $43mn in net cash (as of 6/30/11 - but keep in mind they'll likely use it to make another acquisition soon).
- The book value of the boats they recently acquired in the last 2 years is $161mn.
So take the market cap and subtract their net cash and your paying $74mn for boats marked at $161mn. A 55% discount to their purchase price after depreciation.
The Fear (putting logic behind the sell-off other than the idea it may have just been a big seller who was desperate to sell)
The reason why the stock has sold off is because there's a general fear that the global economy is about to collapse, leading global shipping rates to collapse. If this happens then will DCIX really be able to pay a dividend when they recharter their boats in 2013? Probably not. But will they go bankrupt, nope.
My conclusion is that even if charter rates collapse to a level that is unprofitable for DCIX through 2013 (which keep in mind would be a hell of a recession / depression) their annual operating expense is ~$4mn. They could burn cash or liquidate boats to hold them over for when rates improve. When they do, you'll ultimately be sitting on an asset that if purchased at current prices will start paying you at least a 10% dividend.
Conclusion
I consider this sell-off a good reflection of the volatility and opportunity in small cap stocks. All it takes is a few large sellers to crush the stock. That said, I think anyone who buys right now and can stomach the volatility, will be in the money.
Disclosure: I own DCIX.
Friday, August 5, 2011
DOWNGRADED
Holy shit balls.
Just read S&P downgraded the USA. I'm not sure what ramifications this would imply as a least a portion of the volatility this week was discounting a downgrade. Either way, this could be very serious come Monday morning.
We'll see if the market pukes but I honestly don't know what will happen.
Just read S&P downgraded the USA. I'm not sure what ramifications this would imply as a least a portion of the volatility this week was discounting a downgrade. Either way, this could be very serious come Monday morning.
We'll see if the market pukes but I honestly don't know what will happen.
Tuesday, August 2, 2011
S&P Down 2.5% Today
S&P closed down 2.5% today. I took off half my hedge (from 12% to 6% of the portfolio) given that the debt ceiling passed. I left the other half on, however as there's reasonable odds it can break down further from here. This is a little bit of thesis drift given that I only put on the hedge due to my concern of a U.S. default. That said, I think there's room for downside as investors realize that the only thing propping up this market has been 1.) emerging market growth and 2.) government stimulus (fiscal and monetary). While emerging markets can go either way (China sure does seem like bubble territory), 2012 will be a period of less stimulus.
Thoughts on the Hedge
In retrospect this trade is a perfect example of a good hedge. At most I could have lost was ~0.2-0.5% while the upside was disproportionate. I don't say this to pat myself on the back, but because I stumbled upon something that I should study for future consideration.
Interestingly enough, the hedge is currently up ~2.5% as the market has sold off despite raising the debt ceiling.
DCIX
I increased my position in DCIX to 8% today. They report tomorrow morning. Fun times.
Thoughts on the Hedge
In retrospect this trade is a perfect example of a good hedge. At most I could have lost was ~0.2-0.5% while the upside was disproportionate. I don't say this to pat myself on the back, but because I stumbled upon something that I should study for future consideration.
Interestingly enough, the hedge is currently up ~2.5% as the market has sold off despite raising the debt ceiling.
DCIX
I increased my position in DCIX to 8% today. They report tomorrow morning. Fun times.
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