Saturday, January 13

Portfolio Update: Everything is Awesome (for now) - Valuation & Psychology Edition...

(Apologies to all who are getting this for a second time, there was a small issue with the blog which corrupted the original post).

As regular readers know, the market-wide valuation measure that OM pays the most attention to is Professor Shiller’s Cyclically Adjusted Price to Earnings (“CAPE”) ratio.  Like all measures of valuation it unquestionably has flaws – as some kind folks point out here, here and here – so bear that in mind as you read on! 

Source: multpl.com

First off, the headline CAPE numbers are pretty scary; valuations were only higher during the 1999/2000 Technology bubble, eek!  Wait, but OM’s just spent some blog posts telling you he owns a bunch of risky distressed and/or emerging markets stuff like Brazil, Argentina, Uranium and Greece, and that everything’s awesome – this makes no sense!  Worry not kind reader, OM has not taken (complete) leave of his senses; yes, this chart does look horrific.  But…it is a data point, not a fait accompli, and like many good data points the value is in the context and nuance.

OM is a fan of CAPE, but he accepts it for what it is; a fine measure of long-term value that’s a good guide to long-term (10-year) returns.  Crazy, I know, that a measure that uses 10-years of adjusted data is best used at predicting things over a similar long-term span.  What CAPE is not, and the same holds true for every other valuation measure, is a good indicator if markets are about to crash (or rally).   So the next time you read an article saying “CAPE = X therefore Markets = Y”, or your favorite pundit is filling his 60 second slot on TV with “CAPE didn’t predict (or peaked after) X or Y, and is thus flawed” then for your own sake ignore them.  Sadly, we’re in age where common sense requires data to be believed so OM won’t just ask you to trust him on this.  Fortunately, we’re also in an age where the answers are available if you’re willing to look.  In this case, Vanguard comes to OM’s data-rescue with this most helpful chart from 2012 that shows CAPE is a pretty good guide on long-term returns and everything sucks at predicting next year's.

Source: Vanguard

So, onto the nuance.  It’s January 2018, so (the most updated) CAPE calculations are based upon data from Q4-2007 through Q3-2017.  As Q4-2017 earnings are announced in the coming weeks, they will replace the inflation-adjusted Q4-2007 numbers and as 2018 progresses the 2008 numbers will drop out of the 10-year look back.  Well, pre-crisis earnings peaked in Q2-2007 and during the Great Financial Crisis they fell 90% to trough in Q1-2009.  As the data from the Financial Crisis drops out and is replaced by today’s earnings, the Earnings part of the CAPE is going to look a whole lot stronger.  Folks have tried to model/show the specifics but what matters is that CAPE is going to fall over 2018 (and into 2019) unless either (i) the stock market is up a lot (the P in CAPE), or (ii) something happens to decimate Earnings immediately (i.e. think more nuclear attack, rather an economic recession which needs time to impact things). 

What intrigues OM is the potential change in sentiment (dare he say narrative) from a “CAPE is crazy high” to a “CAPE is high but falling” world.  While fundamentals (and value) provide underpinnings for great returns, it is sentiment and especially sharp changes in sentiment that create the necessary conditions for those returns.  Distressed situations – including Brazil, Argentina Greece, and Uranium – are plays on people’s fear, and it is the depressed valuations coupled with the shift from “this is abysmal” to “there’s challenges, but this is not too bad” that creates the returns.  Today, for the broader markets that are fairly (to expensively valued) it’s the move from “things are pretty good” to “everything’s awesome” as investors’ greed sees them extrapolate out all the trends and find ‘good’ reasons to ignore the warning signs.  While we are still some way from speculative excess, OM thinks he has started to see increasing signs of people wanting and starting to believe…Here are some signs that have piqued OM’s interest.

  • Global Economic Growth:  As the first post noted, it’s the first time in a LONG time that everything’s looking pretty rosy globally.  Don’t underestimate what not hearing about economic strife does to people’s risk appetites.  The longer it continues, the more likely people are to extrapolate and expect the good times to roll.
  • Length of the recovery:  This has been a long recovery, and a key argument against it has been that it has been very uneven with metropolitan areas doing well, while the rest of the country failing to keep up.  The sheer length of the economic rebound coupled with the demographic trends (people leaving the NE/Midwest for the South and West) means this will naturally change.  Conor Sen wrote a timely piece on this, and it plays neatly into the next point.
  • President Trump: Whatever one’s opinion of the President, I think we can all agree that (i) he likes to be flattered, and (ii) that he enjoys taking credit for anything that goes well.  Hence, good economic facts and rises in the stock market are worth Twitter victory laps.  Under President Trump, EVERYTHING IS AWESOME and if it’s not its (pick a group)’s fault and only he can fix it.  It doesn’t matter whether it’s true, if the data keeps rolling in then he will keep saying it.  If you say it long enough, then people might even start to believe itthe signs are that they already do!
  • 2008 (and especially 2000) fades from memory:  The further we get from 2000/2008, the easier is to forget the lessons and attribute the events to foolish other people or our naive younger selves.  There’s a reason why there’s a popular misquote about history rhyming.
  • Corporate Margins & Tax Cuts:  Corporate margins are near all-time highs, and Congress has just passed a healthy tax cut designed to benefit corporations yet more.  This will be good for corporate earnings, and Our Man suspects that (in the short-term at least) a little of it might even find its way into wages.  Not too much, of course – since wage rises are regarded as bad for corporations and by the Federal Reserve – but enough to make the wage earners feel a little happier and more optimistic.
  • Deals: We’ve started to see mega-mergers and IPOs reappearing, the bigger and more publicized these get the nearer we’ll be to the end of the road.
  • Big Tech:  In Things From My Newsreader, Our Man mentioned the pushback that bit tech was starting to get.  These firms continue to receive every increasing amounts of media coverage (both positive and negative), and while the companies are starting to get some pushback, the stocks (and those of international peers, e.g. Tencent) continue to rise inexorably.  If Our Man is right, these trends will continue so expect to hear a lot more about Amazon, Apple, Google, Facebook, Netflix, Tesla, etc and how they’re going to change the world, how they’re ruining the world, and how much their stocks keep rising.
  • Cryptocurrencies:  Our Man suspects that we’ll look back at cryptocurrencies as the tinder that helped fully unleash the animal spirits.  The blockchain is a great concept but early in its lifecycle (like the Internet in the late 90s) and much is still to be proven and determined.  Thus at this stage it’s a better narrative than product/tool and like all good ideas, it’s ripe to be extrapolated to beyond its current limits.  While the claims of grandeur may come true, it’s already at the stage where it has true believers insisting that it will change the world (Everything will be AWESOME!).  The world we inhabit means their $ profits validate these opinions, and just in the last couple of months we’ve seen a broadening out as people’s greed and FOMO see them join the party.  After all, Coinbase now has more accounts that Charles Schwab.

Final Thoughts
So in summation, get ready!!   OM’s working theory* is that if 2017 was the slow and steady chug to top of the rollercoaster, 2018 (into perhaps 2019) is going to be the insane part, with much more volatility and the possibility of much much higher prices.  It goes without saying, that Sod’s Law dictated that while OM put-off completing this piece over the holidays, someone far smarter and more productive came out with a better (and more aggressive) version of it.   Read value investor and bubble historian Jeremy Grantham’s piece – it’s great and OM hopes he’s right.


* As a ‘sensei’ of OM would say; have a working theory you believe in and then project, monitor and adjust.  In that vein, expect a future post with a list of things that OM is going to be keeping his eye on to help him work out if he’s wrong.

Thursday, January 11

Portfolio Update: Everything is awesome (for now)…Part I


To supplement the recent portfolio updates on some key positions, OM wanted to talk about his ‘market view’.  He’d normally spare y’all from this but it seems appropriate since the portfolio is the ‘riskiest’ it has ever been.  While OM’s broker’s limited metrics don’t show it, OM thinks of the positions in Brazil, Argentina, Greece and Uranium as being rather correlated and thus the portfolio is riskier.  In addition to the prevalent Emerging Markets risk, all are situations where the broad theme is similar; an element of stress/distress but a combination of fundamental valuation support and catalysts to change investor psychology offer opportunity.  Given the size of these positions, and the risk, Our Man is going to touch on the macro outlook, and then on valuation and psychology to hopefully explain why he’s so comfortable (at the moment).

Macro Outlook
Let’s not bury the lede, as we enter 2018 everything is awesome…



Our Man is a firm believer that recessions and crises don’t come from nowhere, and that there are warning signs for those who are willing to look.  This does not mean that recognizing the warning signs will be easy, and there will be mistakes along the way, but it behooves us to try.  With regards to the US, current data is uniformly rock solid; OM has posted the GDP graph below, but you could look at jobless claims, average hourly earnings, unemployment, inflation, etc. and the story would be the same.  Yes, most of these are lagging/coincident data (i.e. tells us how the economy was/is doing, not how it will do) but there’s no hint of a breakdown.



In terms of forward looking macro data, OM has historically found the Chicago Fed’s National Activity Index to be helpful and timely; it shows no sign of decline.  This is supported by other leading indicators out there such as the St. Louis FED's Leading Index for the US, the Conference Board’s Leading Economic Index and the Philadelphia FED’s state leading indexes.
The best market-based measure for recessions has been the inversion of the yield curve - when long-term Treasury yields are lower than the short-term ones - as it has been an accurate historical forecaster of past recessions.  The US yield curve has been flattening for the last couple of years and it is now at a level last seen before the Great Financial Crisis, which some see as an early warning sign.  However, as the graph below shows, the yield curve has historically inverted well before (i.e. 1-year+) any recession.  Thus, with the yield curve flattening but yet to invert, OM thinks there is more than enough time to enjoy the sunshine.

To summarize, the US continues to enjoy a prolonged spell of economic growth and is enjoying a “beautiful normalization” following the crisis.  What changed in 2017, was that this became a global occurrence; 2017 was the first year since the crisis that the global economy was operating at full potential.  This trend was visible across all regions and different economies, with World GDP growth at 3.0% comfortably outpacing the World Bank’s June expectations (by 0.3%).  Special shout-outs to Japan, which has had its longest growth boom since 1994, and Europe, which has rebounded strongly and where PMI’s suggest continuation in the near-term.

There are legitimate concerns for investors, but for now the economy is not one of them.  EVERYTHING IS AWESOME!!!

[OM will be back with Part II on Valuation and Investor Psychology tomorrow]

Saturday, January 6

Things from my Newsblur; 2018 - Part I

A New Year means a new start for “Things from my Newsblur”, with renewed hopes of greater frequency.  As usual, the more serious and the finance-orientated things are nearer the end. 

Pep Guardiola is the best football manager in the world, and with him Manchester City have become (by far) the best team in England and a real challenger in Europe.  This is only the start of City’s plan though, and like all amazing and disruptive plans it is part inspiration and part evil genius.  (The Guardian, Giles Tremlett) 

Inspired by Moneyball math, and with the plethora of data now available (thanks Wikipedia!) why not make a semi-serious attempt to quantify the Greatest Generals of all time?  Spoiler alert:  It’s only battle tactics, not overall strategy.  Also, no method is perfect, and Generals from the old days did much better than modern ones; the benefits of getting to fight many battles!  (Towards Data Science, Ethan Arsht) 

The machines are coming, the machines are coming, don’t panic!!!!   If they’re anything like this bot, then future JK Rowling’s (and the rest of us) are safe for a while! (The Guardian, Allison Flood) 

Scott Galloway was well ahead of sentiment turning on the Big 4 Tech companies (Amazon, Facebook, Apple and Google).  I suspect it’s still likely early in that process.  This piece from back in September has a good look at their weaknesses and what they could do to protect themselves.  (L2, Scott Galloway) 

Scott Galloway (of the previous) post has also been arguing that the regulation of Big Tech will likely start in Europe (and potentially some red states with ambitious AG’s).  Europe suffers from all the social and privacy costs, but gets few of the benefits from US Tech companies that minimize their European taxes.  This ruling by the European Court of Justice, with no possibility of appeal, that Uber is a taxi company rather than a technology company is likely the start not the end of such moves.  (Bloomberg View, Leonid Bershidsky) 

Regular readers know that Our Man loves a good oral history.  With the infamous Black Monday, when the Dow and S&P 500 both fell over 20%, turning 30 in October – what better time for an oral history!  Richard Dewey gets a truly impressive cross-section of market practitioners (there are too many for OM to list) to recollect the events of the day and those around it.  (Bloomberg Markets, Richard Dewey)


And finally, while President Trump was likely the most over-reported US story of 2017, OM think it is clear that the most under-reported was ‘Opioids in the US’.

The CDC released figures showing 63,600 died from drug overdoses in 2016, with the final total for 2017 expected to be worse.  To put those numbers into context, “58,000 US soldiers died in the entire Vietnam War, nearly 55,000 Americans died of car crashes at the peak of such deaths in 1972, more than 43,000 died due to HIV/AIDS during that epidemic's peak in 1995, and nearly 40,000 died of guns during the peak of firearm deaths in 1993.”

Here are four recent stories to ponder further. 
This is How the Opioid Crisis is Changing America (Bloomberg Politics, Jeanna Smialek)

Tuesday, December 5

Portfolio Update: Uranium

Uranium 10.2% (as of 11/30/17, in the Commodity Book) 

OM outlined his initial thesis on Uranium stocks back in April.  Here’s the brief recap…
- After a multi-year price war as suppliers sought to build/maintain market share, 2 producers now control over 50% of supply.  It also takes years (literally, 5-7 years) to test drill, permit and build a mine. 
- The primary demand is nuclear power plants.  The 2011 Fukushima earthquake resulted in mass shut-downs (Japan and Germany) but we’re very slowly seeing Japanese plants come back online and new plants being approved and built (China and India).  Existing plants have long-term contracts (2-10years), with the majority coming due in 2018-2020.

The combination resulted in an industry operating with the price of the commodity beneath the cost of its production.  Yet, illogically, nobody wanted to cut production and so the suppliers kept producing at negative cashflows even as nuclear plants remained sidelined (or on the drawing board) post-Fukushima.  Lo and behold, uranium and the suppliers’ stocks got monkey-hammered (or insert your dramatic adjective of choice), with the URA ETF collapsing 80-90% from its 2011 peak. 

However, irrationality can only last so long, and (almost) nothing goes down forever.  After a brutal five years of cash flow negative production, and no investment, sanity finally returned.  The two biggest players (Cameco and Kazatomprom) both announced production cuts in 2016, and URA confirmed a yearly uptrend in 2017 (the price was higher than any level seen in 2016).  Despite volatility, URA never retreated to its 2016 low, and the combination of the fundamentals and technicals was enough for OM to take an initial position.

So what has changed?  Cameco just threw in the towel!!   It shut down two of its Canadian mines, one of which is the largest in the world (11% of supply) for at least 10 months.  The shut downs come replete with some dazzlingly blunt comments from the CEO, including that due to the oversupply in the market “it does not make economic sense for us to continue producing at McArthur River and Key Lake”  and “we can actually buy uranium cheaper than we can produce it.

Read that last one again, and let your mind boggle.  The CEO of the 2nd largest uranium producer in the world, closed down the world’s largest uranium mine (which is in the bottom half of the total cash cost curve globally) because it is cheaper to buy uranium in the open market. 

With evidence of supply-side discipline finally arriving did OM go out and buy some more uranium?  Hell yeah, he did – adding to URA and starting a small position in NexGen Energy (NXA, which owns attractive deposits in the Athabasca Basin, Canada) in the days following Cameco’s announcement.

STOP THE PRESSES 
OM intended to post the above over the weekend.  Thankfully, his failure to do so, means that this post isn’t already out-of-date.  Why?  Well, I’m glad you asked!  In the above post, OM had studiously avoided the rumors that the Cameco cut was choreographed with Kazatomprom, who would announce something similar when the dust had settled.

Want to guess the news that OM woke up to today?  Another England collapse in the Ashes, of course.  But other than that?  Oh, just Kazakhstan saying it will reduce its uranium output by 20% over the next three-years starting in January, thereby cutting global uranium supply by another ~10% over that period.  

Surely a coincidence that the two biggest players cut supply within weeks of each other to balance (if not more) and over-supplied market.  What fortunate timing too, given most long-term supply contracts are coming due over the next 3-years.  The intriguing thing about market-related psychology is that it can work in both directions.  Will the disciplined nuclear utilities, who saw an over-supplied market and were content to run down their inventories now see a market that’s moving towards being under-supplied and race each other to secure new long-term contracts?   After all, I’m sure Cameco and Kazatomprom are well aware that the last time there were large contract rolls, which coincided with supply disruption (due to the flooding of the Cigar Lake mine), it was 2006 and spot uranium went up 4x in less than 18months.

Saturday, November 18

Portfolio Update: Argentina, Greece and India

Argentina 9.7% (International Book)
Argentina has been a long-held thesis in the portfolio, it is approaching its 3rd anniversary, with the initial thesis being that the 2015 elections would bring significant change.  The crucial fact was that President Cristina Fernandez de Krichner couldn’t run in the election, after being term-limited and failing to secure the necessary votes for a constitutional amendment.  Under Cristina, Argentina had largely been isolated from the world markets with capital controls and a pegged currency that traded at a significantly different level in the black market (the ‘blue rate’).  The country was also involved in a long-running argument with bond hold-outs that ended with Argentina losing in court and being shut out of the global debt markets.  The result was an economy with significant imbalances (government subsidies/interventions), a large government deficit, runaway inflation, and exceptionally high interest rates. However, this also meant that Argentina was a country with very limited government debt - a benefit of not being able to borrow internationally!

The opportunity was that all 3 candidates, including the one favored by President Kirchner, were all likely to be substantial improvements.  As luck would have it, President Macri, the eventual winner, was viewed as the most market-friendly candidate (and no ally of President Kirchner).   Any doubts were dispelled in the first 100 days with an array of actions including floating the currency, removing capital controls, granting independence to the central bank (with a mandate to reduce inflation), announcing substantial reforms/ cuts to subsidies, settling with the old bond holdouts, and subsequently raising debt in the international capital markets. 

Unsurprisingly, markets rejoiced…including Our Man’s Argentinean basket of stocks, which are up 140%+.    OM expressed the Argentina theme through a small basket (5-6) of stocks as the ETF (ARGT) was a poor reflection of the opportunity (commodity heavy + largest position is focused outside Argentina).   The basket has steadily been pared back to OM's 2 favorite names, Pampa Energie (a beneficiary of electricity subsidies being cut) and Adecoagro (an agricultural company).

The recent strong win by President Macri’s party in congressional elections only increases the chances of reforms, and the possibility that Macri will run again.  With a low-level of government debt and wide-open credit markets, Argentina will continue to have the opportunity to reform at a reasonable pace.  Add to that a newly independent central bank that has been willing to raise rates to conquer inflation.  There are positive signs as inflation has started to fall and this is widely projected to continue.   

To Our Man this rather rhymes of a certain 1980’s US President who reformed an economy and saw the Federal Reserve defeat inflation.  That started a multi-decade boom for numerous asset classes in the US. So don't expect Our Man to exit Argentina any time soon (even if he can’t invest in Argentinean PE, which is likely the best asset class)!!  


Greece 2.7% (International Book)
Our Man’s previous Greece exposure was exceptionally disappointing – too early and over-sized – but like a moth to a flame, he has returned.  Yes, OM can see you shaking your heads sadly – so, why now?

The French.

Yup, I kid you not.  The Frogs have gone and done it!  It being, breaking the impasse between the Eurogroup (*cough* Germans) and the IMF over a longer-term plan on Greek debt sustainability - “The Eurogroup formally agreed to a longer-term French plan to link the scale of Greek bond repayments to the country’s economic growth…

So, now we’re finally near the end of the tunnel and by golly there’s light!  The light is Greece exiting the bailouts in mid-2018, with the banks looking like they are in decent shape to pass the final stress tests, and the market being prepared for new Greek debt.  And the tunnel?  After a 45% fall in GDP – the same decline as the US saw during the Great Depression - finally some stability and growth and a small government surplus.   And so, OM is back and hoping that the clearer catalysts (stress tests, exiting the bailout, issuing debt in the market and perhaps even elections) will stop the portfolio from seeing a second Greek tragedy. 


India 3.3% (International Book)
Our Man has a small position in India.  Though the % of NAV is larger than Greece, it is a much safer investment.  It has neither the substantial risk nor the same massive potential short-medium term upside as the Greek position.   

The long-term bull case for India is very widely known, and OM doesn’t have any special insight bar noting that the speed and prolonged nature of these changes is often under-appreciated.  The long-term bull case starts with the 2nd largest country in the world, which also (unlike the largest) has great demographics (working age population is not expected to peak for at least the next 10yrs).    

This is supplemented by some self-help.  The Modhi government has been busy (not always in a good way) and has made some structural shifts (taxation changes, bankruptcy code reform, financial reforms, etc) that will have long-term benefits.  However, the most interesting to OM is the push to digitize the economy, highlighted by the introduction of Aadhar (a unique individual ID number based on biometric information).  Unfortunately, most of the potential applications (loans, credit history, transaction confirmations, to name the obvious ones….) of this are “in the future” and many will initially be captured in the private markets (and OM is not a VC).  Thus, until OM has a clearer idea of how to directly benefit, expect India to be a small but consistent part of the portfolio.






Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take the above that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc. 

Saturday, October 28

Portfolio Update: Brazil

Brazil is the largest position in the portfolio by a significant margin, as OM feels it’s in that sweet spot when all of the relevant factors all line up.  Given how out-sized it is in the portfolio, Brazil is getting its own little write-up

Brazil: 25.8% (International Book) as of 9/30/17
The long-term argument is simple; Brazil’s long recession, and the equity bear market that lasted from 2011 to 2016 which saw an almost 80% loss (in USD-terms) is over.  The market bottomed in Jan-16 and a new cyclical (possibly event secular) bull market is beginning.  Furthermore, the public discourse around Brazil and investor sentiment reached a nadir in Q2-16 as the ‘Carwash Scandal’ enveloped the ‘elite’ business and political class culminating in the successful impeachment of President Rousseff.

So why invest?  Well, the highest return potential is when a situation improves from one that is terrible and completely ignored by investors, to one that’s ‘okay’ and attracts curious interest.  There were clear signs of this in Brazil during the middle of 2016 across a range of areas;
- At a macro level the balance of trade turned positive (historically a very good sign for Brazilian equity markets). 
- President Temer, the new President was viewed as a short-term President, and with politicians already held in contempt by the populace they were ironically more amenable to taking actions (i.e. economic and pension reforms) that they normally tried to avoid. 
- At a corporate level, both friends and professional contacts of OM said similar things; that companies, irrespective of sector, had to cuts costs to the bone to survive the last 5-years.  Many only survived as a result of competitors going out of business.  Or in layman’s terms, if there were any growth in demand these firms have a better competitive position and operating leverage! 
- While speaking with numerous Brazil-focused portfolio managers, Our Man kept hearing that fundamentally stocks (especially outside the most liquid names) were exceptionally attractive but…
The phrases after the “but” always represented the various constraints - self-confidence after a bear market, market concerns, what clients would think, potential business risk, etc. - that prevented the portfolio manager from participating (for now, in OM’s view).
- Finally, after a seemingly continuous fall the Brazilian market (in USD-terms) finally started to turn around, impulsing higher in early and mid-2016 and leaving the lows well behind. 

With this mix of promising signals, and the opportunity created by a short-sharp pullback in the wake of the US election, Our Man began his Brazilian position split between large-caps (EWZ) and small-caps (EWZS) in late-2016.

The data over 2017 has largely started to confirm many of the original premises.
- As noted, in the Q2-review, President Temer’s probability of being a short-term President increased after he was allegedly caught on tape discussing hush-money payments to jailed powerbroker Eduardo Cunha.  The entire process, which ended with him surviving an impeachment vote, ensured the public’s low esteem of politicians remained unchanged.  Yet, the probability of reforms passing increased with him surviving impeachment.
- Temer’s troubles led to a 20% pull back in May, which saw a subsequent bounce before retesting the May lows before rallying once more.  This created the technical sign for Our Man to add to his position, before adding once more as the rally went through the highs seen in May.
- The economy continues to improve on multiple fronts, be it GDP finally turning positive 

or inflation falling dramatically

or the balance of trade looking the healthiest in years.

In summation, to Our Man’s mind, Brazil is setting up as a perfectly positive storm of fundamentals and technicals meaning OM sees a de-risked (for example, versus 12mos ago) situation that is getting ready to continue its sharp rise.  Unless he’s horribly wrong and the Q2 lows are tested, OM hopes that despite the inevitable volatility he won't even be trimming his positions back till they're significantly higher or Brazil’s 2018 election is in he headlights.


Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take the above that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.  

Thursday, October 5

2017: Third Quarter Review

There were a number of changes to the portfolio during the quarter.  A brief summary is below, but expect a broader portfolio review (likely in multiple parts) in the coming weeks.

International: 
- Added to Brazil (EWZ & EWZS): As readers will remember, Brazil fell heavily in mid-Q2 after recorded conversations (re. accepting a bribe) involving President Temer led to an impeachment attempt and potential criminal charges.  In mid-to-late-July, it became clear that these charges wouldn’t be accepted by the lower house of Congress (subsequently confirmed by a vote in August) and in late August the Brazilian market broke out to new highs.  OM added to the Brazil position on each of these events (in larger size on the breakout to new highs).  This makes Brazil the largest position in the portfolio.
- Bought India (INDA & SCIF): OM started a small position in India.  He’s been looking at it for a while, as it’s somewhere that’s likely a multi-year holding but was always too price sensitive.  Call this a first nibble at what might one-day be a much larger position.
-  Bought Greece (GREK & ALBKY): OM’s previous investments in Greece have been far from stellar (i.e. terrible) yet he returned to that poisoned chalice just before quarter-end.  Why now?  Time (and recapitalizations) help heal balance sheet wounds, and there was a small (under-reported) catalyst on debt reduction.  The initial position is very small - it would have to triple to cover prior losses - but the return potential is substantial and OM thinks the market is over-stating the risk.
- Exited Italy (EWI): OM exited the Italy position.  It has performed well, but other opportunities (i.e. Greece) are just more attractive at this point.

Equity: 
- Exited Dollar Tree (DLTR): While Dollar Tree is a beneficiary of tax reform (if it comes), with Amazon’s purchase of Whole Foods and stronger ideas out there, it was an easy sell.
- Exited Liberty Broadband (LBRDK):  This was actually the toughest decision in the portfolio, since Charter Communications (LBRDK just owns Charter and a subsidiary) is a fantastic business with good opportunities ahead of it.  There are some very good public write-ups about why Charter Comms (and thus LBRDK) will be worth substantially more in the future, and OM largely agrees with them.  In the end there were just things OM has greater confidence in.
 - Bought Texas Pacific Land Trust (TPL):  TPL is a publicly traded land trust that’s self-liquidating as it buys back shares with excess cash.   The trust benefits primarily from oil & gas royalties (the Trust’s land is located in the Permian basin), which have risen over the last 4-years even as the oil price has fallen.  Interestingly, in the middle of the year the Trust announced the formation of a subsidiary to provide water resources.  Given TPL owns the water rights under its land, there is opportunity to supply water to drilling companies and find ways to recycle the (non-potable) water that’s a byproduct of drilling. 

Currencies 
- Exited Short Euro (EUO): Our Man exited the short Euro trade in mid-late August.  Though it’s been a fantastic contributor over a number of years, the end was bittersweet – as noted previously, it should have happened earlier in 2017.  The exit also marked the end of Our Man’s dollar bull thesis – in its various guises (and including the Short Australia dollar positions, within the China Thesis) it ended up contributing over 1,000bps to performance!  It should have been more 😔...

China Thesis: 
- Added to Chinese A-Shares (ASHR):  Our Man materially added to the A-shares position during the quarter.  China is a swirling surfeit of liquidity seeking somewhere to call home, drive up prices and then move on once more when the authorities play whack-a-mole.  We've seen it at least once each in real estate, domestic equities, commodities, and most recently bitcoin.  With the authorities making it harder to invest in bitcoin (the latest home), the liquidity is on the hunt once more.   OM is wagering that the 19th National Congress starting in Q4, will offer the stability for local equities to shine once more after the boom/bust of 2015.  Technically, they’re setting up well and OM wouldn’t rule out a run at 2015 (or even 2007) highs.
- Exited Short Australian Dollar (CROC):  Much like the short Euro position, OM exited this position during the middle of the quarter.  Unlike the Euro position, the sin wasn't holding it too long, it was re-entering/sizing it in Q2 despite the technicals looking unattractive.

Commodity: 
- Added to Uranium (URA):  OM sized up the position in Uranium mining companies (URA) after the recent pullback held above its 2016/2017 lows (spot uranium also held above its 2016 lows).  This coupled with Japanese power plants slowly coming online and the supply discipline holding creates an interesting opportunity.

Performance and Review 
The second quarter saw OM’s portfolio rise 512bps, while the S&P 500 (TR) rose 4.5% and the MSCI World was up 4.1%.  For the year, this left OM’s portfolio +13.4% compared to +14.2% for the S&P 500 (TR) and +13.0% for the MSCI World.  

Performance was driven by the International/Country book (+476bps), with Brazil being the primary contributor (just over 300bps).  As noted above, Brazil bounced back sharply from Q2’s Temer-related fall, and OM was helped by added to the position in the quarter.  Argentina and Italy were also healthy contributors.

The Technical book (+124bps) was a direct beneficiary of the market rise.   The Funds book (+39bps) also rose with the market, though it underperformed during the quarter but remains comfortably ahead of the market in 2017.  The Equity book (+14bps) was only a marginal contributor with negative performance from Vipshop Holdings (VIPS, -59bps) offsetting most of the gains driver by Liberty Broadband (LBRDK, +36bps) and Biotech (IBB, +34bps).

The China Thesis (-42bps) and the Currencies book (-81bps) both detracted from performance due to the long Dollar exposure before those positions exited the portfolio.  Finally, the Commodities book (-18bps) hurt as Uranium stocks continued to muddle around.

Portfolio (as at 9/30 - all delta and leverage adjusted, as appropriate)
41.4% - International (Brazil, Argentina, India and Greece)

25.7% - Technical (DDM, QLD and SSO)
15.9% - Equities (JD, VIPS, TPL, FNMA & IBB)
10.3% - Funds (CWS, GVAL, and CAPE)
9.4% - China-Related Thesis (ASHR)
7.3% - Commodities (URA)

2.9% - Cash  

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take the above that way.  For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a few other securities (of negligible value).  You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.