Sunday, March 18

Portfolio Update (and Vietnam)

Well, that was fun!  After a serene 2017 and a rampant January, Mr. Market handed out a harsh dose of reality during February with the S&P 500 Total Return falling 10%+ intra-month before recovering.  In the midst of this, OM did very little during the month; adding to the Greece position and beginning a new one in Vietnam.  Let’s touch a little on both decisions, before looking more broadly at how the volatility is impacting OM’s view going forwards. 

While the market was hitting its lows, Greece successfully issued a 7-year bond in an oversubscribed offering.  This alone reflects the change in investor perceptions, and is further highlighted by the 3.5% yield on the bonds (or a mere 75bps above similar US Treasuries)!  There remain hurdles to clear, most notably agreeing suitable debt relief and a post-bailout monitoring arrangement, but OM saw the successful bond issuance as another sign that things are on the right track.

The argument for Vietnam is a simple one; it looks like China/Thailand 15-25 years ago and is treading down the same path.
- After the property bubble, there was a long and drawn out restructuring in the bank sector that started in 2011.  It took till 2015 before real estate transaction volumes really started to recover.  Now, with the real estate sector stabilized, the strength of the rest of the economy is becoming more apparent; growth is good, inflation is under control (2.5-5%), rates are low, and the government is using foreign inflows (see below) to build reserves.

- Vietnam has one of the lowest labor costs in Asia, with a young and educated demographic profile.   This comes at a time when labor costs in China (and Thailand) are rising due to an aging population.

- Vietnam is already a consumer-centric economy (65% of GDP) meaning the combination of good demographics (an influx of young workers) and job opportunities (see next point) sets up a virtuous cycle of opportunity.

 - Vietnam is seeing substantial Foreign Direct Investments (“FDI”) from global multinationals.  This began with Samsung’s $13bn investment in 2014 (and follow-up commitment of $7bn more by 2017) and has continued apace with 2017 setting a new record.  The Vietnamese government is continuing with reforms to further encourage foreign multinationals to set-up and invest.

 - In the medium-to-long term, if Vietnam is to follow in China’s footsteps and become the next up-and-coming Asian manufacturing powerhouse, further industrialization and urbanization lies ahead.

- The Vietnamese government has targeted a 70% market cap to GDP ratio (currently ~46.5%), which seems achievable given that similar countries include Singapore (200%+), Thailand (~90%), Philippines (~80%), and Malaysia (~120%).  The government is facilitating this through easing foreign ownership restrictions, privatizations and equitizations.  From OM’s Argentina discussions, you will remember these are all key criteria in moving from being a “Frontier” market to an “Emerging Market” and the wall of $ that brings.  For those that enjoy history’s rhymes, Vietnam’s government floated the company’s largest beer company (SABECO) in late 2016, and just sold a majority stake to ThaiBev.  The historians amongst you will note that back in 1993, Tsgintao Brewery was the first Chinese state-owned company to list in Hong Kong creating the H-share market that has blossomed today.

This week brought further confirmation of the interest in Vietnam, with Warburg buying a stake in Techombank and Amazon poised to enter the country, which both help indicate the strength of the long-term opportunity.

So what did February change in OM’s outlook?  In the immediate-to-short term, not a lot - new highs are likely coming and the speed of their arrival (the quicker the better) will provide more clues as to how far the market might run in the medium-term.  However, it is equally clear that the probability of 2019 being spectacular (think 3,500 on the S&P 500) was significantly diminished by the depth of February’s slump. 

As such, while OM is certainly not forecasting any end of the bull market it’s certainly wise to start preparing for it.  This is something OM is pondering and will be the focus of an upcoming post, but to whet your appetite here are the three positions that are likely most at risk of seeing their position sizes reduced:

- Brazil:  OM’s Brazil positions are very indicative of where the market finds itself, somewhere between rolling over and surging to impressive new highs.  Technically, it’s one of the clearest/most interesting charts out there – based on OM’s analysis, either we see 89-90K on the iBovespa relatively soon and are on the pathway to impressive new highs, or there’s likely a much more substantial pull-back.  Fundamentally, OM continues to like Brazil but with an election coming up later in 2018 it’s unlikely to remain vastly outsized unless we see that push to impressive new highs.

- IBB:  Biotech has done fantastically over the past few years, but of all the things OM owns it looks the closest to exhaustion.  Given how far it has come a pull-back could be substantial, and OM worries that should that occur the receding tide will reveal more Theranos’ swimming naked!   The decline won’t be as dramatic as Tech’s 99/00, but OM is using that as his broad heuristic and will be happy to wait until he hears other investors proclaim how they don’t invest in biotech/binary situations before diving back in.

- Uranium: Fundamentally, and conceptually, OM loves the Uranium thesis – it’s probably his favorite in the book.  However, as the chart below shows the price action sucks – sharp bounces when the production cuts were announced but no follow through.   Unless things turnaround, and soon, expect the position to be vastly reduced.

Sunday, January 28

2017: Fourth Quarter Review

Portfolio Update  
The recent portfolio updates covered most of the portfolio changes in Q4, so OM won’t spent too much time on them: 
- Commodity:  As noted, Our Man increased the Uranium position to ~10% of capital.  The initial increase was through the addition of NexGen Energy (NXE) following Cameco’s announcement of a production cut, and it was supplemented by adding to the Uranium ETF when Kazatomprom also announced production cuts.   

- International: Our Man continued to add to the International portfolio.   The continued positive economic information out of Greece, encouraged OM to increase his exposure (GREK and ALBKY).  The pullback in the Indian market offered an opportunity to add to existing positions (SCIF and INDA).  Finally, the recent IPO of Despegar (DESP), an online travel booking firm, allowed OM to broaden the Argentina exposure. 

- China Thesis: Our Man exited his position in Chinese A-shares (ASHR).  While the position was reasonably profitable, the bull market has lacked the liquidity-fueled vigour that Our Man was hoping for.   The capital is better used elsewhere.

Performance and Review
The fourth quarter saw the  portfolio rise 6.7%, while the S&P 500 (TR) rose 6.6% and the MSCI World was up 5.4%.  This meant that while OM’s portfolio generated a healthy absolute return of +21.0% for 2017, it underperformed the +21.8% rise of the S&P 500 (TR) though it did have the consolation of outpacing the MSCI World (+19.3%).  


After an interminable wait, there was finally some good news on VIPS (+94bps) with Tencent and investing over $850mn to purchase a combined 10% of the company, and agreeing to work together.  The position in JD (+35bps) also rose during the month, with the tie-up seeming to confirm the long-held but largely unspoken belief that JD and Tencent were likely to work together against Alibaba.  Elsewhere in the equity portfolio, there was a good contribution from Texas Pacific Land Trust (TPL, +34bps), which continues to see increased contributions to revenue from its water services business.

The International book saw healthy contributions from India (+58bps), Argentina (+41bps) and Greece (+41bps).  The situation in all three countries continues to steadily improve, with the news of the Greek stress tests and its attempts to re-enter the bond market likely to be key factors in early 2018.  Argentina was the single largest contributor to performance in 2017, adding almost 700bps driven by the continued rise in Pampa Energine (PAM).  Brazil (-47bps) was a negative contributor in the quarter as debate raged over whether former President Lula would be allowed to stand in 2018’s elections.  President Lula was convicted of corruption in 2017, which would bar him from a Presidential run, but in December and appeals court agreed to schedule an early decision.  This re-opened the possibility of President Lula running, should his appeal be successful.   Brazil was also a healthy contributor in 2017, adding 350bps+ to performance. 

The Technical Book showed its value to OM’s portfolio in Q4 and 2017, benefiting from the rising markets.  The book was added in 2014, the first of a series of small changes over the years to hedge OM’s skeptical nature and ensure the portfolio always had some core long exposure.  It’s the “Technical” book as it is based purely on quantifying and investing in long-term trends in the market (S&P, Nasdaq and Dow).  For a recap, of the full details and rules…read here.

The Funds book saw decent contributions from all three positions, and had a good year – it outpaced the market by almost 300bps.  The Chinese A-Shares position contributed well in the 4th quarter, before OM exited the position, and the gains almost entirely offset the early year losses from the Australian dollar short position.  The Uranium thesis finally started to show signs of life in the fourth quarter, with the two largest producers both committed to taking significant capacity out of the market.   The strong fourth quarter meant the Commodity book ended positive for the year.

While OM exited the long US dollar positions earlier in the year, the Currencies book was the big negative contributor in 2017, costing over 400bps.  However, this doesn’t quite paint a full picture as the Brazil, Argentina, Greece, India and VIPS/ positions are all implicitly short the dollar.  As such, while the Currency book housed all of the losses from OM’s long dollar position in the early year, the other books (especially the International/Country) benefited from the implicit short position during the latter portion of the year.

Portfolio (as at 12/31/17 - all delta and leverage adjusted, as appropriate) 
44.8% - International (Brazil 23.3%, Argentina 11.6%, India and Greece)
28.1% - Technical (DDM, QLD and SSO)
16.2% - Equities (JD, VIPS, TPL, FNMA & IBB)
10.2% - Funds (CWS, GVAL, and CAPE)
10.1% - Commodities (URA)
4.6% - 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. 


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! 


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]