OM’s Philosophy: How Today’s Portfolio Fits

As a follow-up to OM’s last piece on his investment philosophy and strategy, this one looks at how the current portfolio fits within that framework.

Dislocations – 35.4% NAV, as of end of June 2018 
OM seeks to take advantage of dislocations – areas of the market where performance has been abysmal and investors have lost hope.  In addition to cheap valuations and fundamentals that are turning around, these investments require a narrative to help encourage investors to reexamine the opportunity.

Brazil (20.3% NAV) 
The longer-version of the thesis can be found here.  The shorter version is that Brazilian equities lost 80% (in USD-terms) between 2011 and 2016, and investor sentiment reached a nadir in early 2016 as the Carwash Scandal enveloped Brazil’s elite culminating in the successful impeachment of President Rousseff.  With sentiment at a trough, there were positive signs; new President Temer was viewed as competent and a short-term fix, and the length-and-depth of the recession meant that politicians were open to reform (especially pension) and companies had spent 5-years cutting costs to survive (i.e. created operating leverage to any pick-up in demand).  This was supplemented by the macro environment picking up (Brazil exited recession in 2017) and stock prices rising.

However, the big current question is whether the narrative peaked in December 2017, when Brazilian stocks continued to rise even as the planned pension reforms were shelved.  If so, this position should be vastly smaller especially considering the uncertainty of the upcoming election.

Uranium (9.5% NAV) 
Uranium remains the most frustrating position in the portfolio, which is a sign that it should probably be a smaller one.  Nothing has changed in the thesis;
- The primary demand is nuclear power plants which are slowly coming back online (post Fukushima) and being built (mainly in China and India).  These plants have long-term contracts (2-10yrs) and the majority of existing contracts come due in the 2018-2020 time frame.
- The supply-side is now rational.  A multi-year price war saw suppliers seek to build/retain market share, but the continued falling price meant there was no investment and most mines currently operate at a loss.  Two suppliers (Cameco and Kazakhstan) now control over 50% of the market, and have both been disciplined and aggressive in shutting down capacity.  Our Man hoped that these public demonstrations of supply-side discipline, especially the major cuts coming into 2018, would help start to drive the narrative and price but despite strong rallies on the shut-downs, there’s been little price follow-through.

Greece (5.6% NAV) 
Greece suffered through the Great Depression (and more) and everyone’s still annoyed/frustrated with them, with investors having been burned more than once.  However, Greece exited its third (and final?) adjustment program a couple of weeks ago and the IMF/EU came to a French-brokered understanding re. its future debt path earlier in the year.  While there is much reform that still needs to happen, it’s also too easy for outsiders to discount what’s already been done (e.g. reforms making it easier to fire workers, new laws to work out NPLs, etc.).

OM has limited the position size since while all the ingredients are in place there is no compelling narrative to force people to look at Greece again.  As such, OM is waiting to see (i) Greece come to market with another debt issue, and especially (ii) elections.  OM suspects that the latter will prove a strong driver of the narrative, especially if Kyriakos Mtzitokis’ New Democracy look like winning.  They represent a much more palatable partner to investors/the EU/the ‘media’/etc. than current Greek PM Alex Tsipras and his Syriza party.

Thematic – 28.8% NAV, as of June-end 2018 
This represents OM’s exposure to long-term secular themes.  The themes likely won’t change much over time though the underlying components and position sizes may do.

The 3^rd/4^th Industrial Revolutions (14.2% NAV) 
The Digital Revolution (3^rd Industrial Revolution) was the shift from mechanical/analogue technology to digital electronics; at the simplest level think sending mail to email.  It began with the invention of the transistor (1947) which led the advent of digital computers, and it continues through today cellphones and the Internet.  The Fourth Industrial Revolution is building upon and extending the Digital Revolution, and seems likely to transform society in the coming years/decades.  So far, it has been characterized by breakthroughs in fields such as robotics, artificial intelligence, machine learning, autonomous vehicles, genome science, and cryptography.  Most will have at least heard of some/most of these fields, but they are all still emerging and their impacts and relative importance isn’t yet known.

Our Man has long-held various technology and biotech names in the old Equities book; while the companies have their own attractive traits, these “Industrial Revolutions” are the overarching theme that binds them together.  OM suspects that by classing all the positions that are predominantly driven by this theme together, it will help from a sizing and risk management perspective.

If you’d like to read a simple primer on the 4^th Industrial revolution, here’s a good one from World Economic Forum.

Argentina (8.0% NAV) 
Argentina started in the dislocation book; Kirchnerism from 03-15 resulted in a poorly managed and distorted economy, with no access to global capital markets.  However, political change was imminent; President Cristina Fernandez de Kirchner couldn’t run in the 2015 elections, and any of the 3 candidates would be more market friendly.  She was replaced at the end of 2015 by President Macri, the most market friendly of the candidates.  President Macri began an impressive liberalization of the economy including removal of currency controls, inflation targeting independent central bank, settling with the bond hold-outs allowing Argentina to access capital markets, etc.  

The thematic bet is long-term that Macri-ism succeeds and Argentina becomes a ‘normal’ country and market economy, with single digit inflation and normalized interest rates.  This allows the development of a broader credit market (both corporate and personal) and businesses have greater ability to plan/invest for the future.  Think of the US in the early 1980s, following Volker’s raising rates to tame inflation, as a good but vastly simpler historical rhyme.

India (4.9% NAV) 
The long-term bull case for India is widely known, and OM doesn’t have much special insight.  The thematic case starts with the 2^nd largest country in the world, which also has great demographics and is (relatively) technologically advanced.  These natural advantages are supplemented by some self-help.  While there is much to criticize the Modi government over, it has made some structural shifts (taxation changes, bankruptcy code and financial reform, etc.) and the push to digitize the economy, highlighted by the introduction of Aadhar (a unique individual ID number based on biometric information), is potentially world-leading.

Vietnam (3.1% NAV) 
The cliff notes for the Vietnam is that it looks like China/Thailand 15-25 years ago and is treading down the same path.  The longer form can be found here; expect Vietnam to be in the portfolio for a long time though the position size will vary depending on the pace of reforms, the strength of the economy and the proximity and likelihood of any MSCI upgrade (to Emerging Market status, from Frontier).


Idiosyncratic – 18.2% NAV, as of June-end 2018 
The idiosyncratic book is made up of two things; a small number of attractive individual stocks and some Funds.  These Funds take advantage of some structural inefficiency be it through active stock picking/time horizon or using a combination of (valuation) factors to systematically allocate capital. 

Texas Pacific Land Trust (TPL, 6.7% NAV) – if there could be a poster-child for the type of individual stock in the idiosyncratic book, it would be TPL.  It’s attractively priced, not covered by any Wall Street analysts (of note), not in any ETFs, and its business (oil royalties, land leases, and water rights) has no real peers to benchmark it against.  Throw in the uniqueness of its structure – it was created in 1988 as a result of the Texas Pacific Railway co going into receivership, and all it does is manage/sell land and use the proceeds to buy back shares – and nobody really knows or cares about it.   

Fannie Mae (FNMA, 0.3% NAV) – Either the government should not be sweeping all of FNMA’s profits to the Treasury and it’s worth multiples of the current price, or they should and it’s worth almost nothing.  For a resolution, it requires political decisions to be made on a topic nobody wants to make-them on (government’s role in the mortgage market) and with no immediate need for a decision.  Think of it as a glorified option with lots of unknowns and very attractive risk/reward payoff.  Also, it has no time decay but also no strike date…it could be here forever and worth the same, or worth multiples next quarter/year.

As previously noted, the Funds (11.3% NAV) are within the idiosyncratic book.
- GVAL and CAPE are both based on applications of Shiller’s PE Ratio (aka Cyclically Adjusted Price Earnings, CAPE).  GVAL applies it to International stocks (finding the cheapest stocks in the cheapest countries), and CAPE applies it to US sectors.  To Our Man’s mind Shiller’s PE Ratio/CAPE is a tool that is poorly applied in finance with too many trying to use it as a timing mechanism or reason for a short-term decision, whereas it’s real value is as a very long-term measure of relative value.  The intent of both ETFs is to buy things that are cheap on a relative basis (compared to other countries/sectors) and Our Man’s wager is that over the long-term this will prove to be more profitable than the market.
- CWS:  Our Man has read the Crossing Wall Street blog for most of the last decade, and this ETF is based off that blog.  CWS publishes an annual “Buy List” of ~25 stocks at the start of each year, which are equally weighted and then no changes can be made during the year.  Each year only 5 stocks from the Buy List have been replaced, with the others carried forward (with any additions) onto the new Buy List.  This longer-term focus (typically, 4-5 years on the Buy List) leads to a bias towards quality and value and if the process can remain disciplined this can lead to out-performance over time.


Technical - 32.9% NAV, as of June-end 2018 
The Technical book was added back in 2014, to help compensate for OM’s natural skepticism by formulaically take long positions (in the levered ETFs for the S&P 500, Dow Jones and Nasdaq 100) to capture long-term trends in these markets.  The position-sizing of these positions is also rules-based, and more information on the genesis and rules for the Technical book can be found here.


Hedges/Shorts 
None currently.

Portfolio Update

Given there were a number of new additions to the portfolio at the end of 2016 and in early 2017, this seems like an appropriate moment to look at the various books/themes in the portfolio and talk a little more about them.


Technical: 22.7% NAV (all sizes are as of March-end) 
The positions are unchanged and are relatively evenly split between DDM, SSO, and QLD, which represent exposure to the major US indices   Currently Our Man’s technical model is strongly in “Buy” territory, and while it indicates there are possibilities of 5-8% pull backs in the near future barring a much more substantial reversal in markets it seems unlikely that its recommendation will change.  Thus, Our Man’s not expecting much to change here for a while.


International:  20.1% NAV 
This book currently has positions reflecting themes in Argentina, Brazil, and Europe (Italy).
- Argentina (8.9%) is the largest theme, though this was reduced during Q1 as OM exited PZE (Petrobras Argentina, which rallied strongly in late-2016) and reduced the size of the PAM (Pampa Energie) position.  The remaining exposure to the theme comes through Pampa (6.4%) and Adecoagro (AGRO, 2.5%).  It’s now been over a year since President Macri took office, and he’s made a remarkable number of changes to help Argentina transition towards a more market-based (vs. government driven) economy including the removal of capital controls, allowing real independence to the Central Bank (which has since decided to target inflation), settling with bond holdouts opening the way for Argentina to raise USD debt, and reducing government subsidies and price caps.   While these things are only now starting to impact the economy, they have already improved investor sentiment which is highlighted by the prospect of Argentina returning to the MSCI Emerging Markets Index this summer.   While OM hopes to see the benefit of the increased liquidity and flows, the position is likely to be one that declines as Argentina continues its move towards normalization.

- The recent additions of Brazil (7.6%) and Europe (Italy 3.7%) were discussed in the year-end review.  Both positions are likely to increase in the future, especially if the recent pullback in Brazil continues.

- Finally, at the start of the year, GVAL was removed from this book and added to the new Funds book (see below)


Equities: 19.3% 
The equities book is made up of broadly evenly sized positions (~3.5%) in JD.com (JD), Vipshops (VIPS), the Nasdaq Biotech ETF (IBB), Dollar Tree (DLTR) and Liberty Broadband (LBRDK).  JD (which Our Man re-entered in January at a mildly better price than he sold it at last year) & the long-held VIPS position are both plays on the Chinese Consumer; think of them as companies that one day could be Amazon & an online TJ Maxx respectively.   Both Dollar Tree and Liberty Broadband (mainly Charter Communications, whose services fellow New Yorkers see as the new “Spectrum”) are exceptionally well run businesses which would also would be beneficiaries of tax reform in the US.

There is also a much smaller position in Fannie Mae (FNMA, 80bp), which along with the position in IBB was discussed in the year-end review.


Funds:  9.9% 
This represents a new book/theme in the portfolio; all of the exposure is expressed through ETFs (or potentially funds).  These ETFs have something about them that has piqued OM’s interest and are why I think they’ll outperform markets over the long-term.   Given that this outperformance is expected over the long-term, the changes to this book are expected to be extremely small.  Currently, there are 3 broadly equally-sized positions in the book:
- GVAL and CAPE are both based on applications of Shiller’s PE Ratio (aka Cyclically Adjusted Price Earnings, CAPE).  GVAL applies it to International stocks (finding the cheapest stocks in the cheapest countries), and CAPE applies it to US sectors.  To Our Man’s mind Shiller’s PE Ratio/CAPE is a tool that is poorly applied in finance with too many trying to use it as a timing mechanism or reason for a short-term decision, whereas it’s real value is as a very long-term measure of relative value.  The intent of both ETFs is to buy things that are cheap on a relative basis (compared to other countries/sectors) and Our Man’s wager is that over the long-term this will prove to be more profitable than the market.  The GVAL position was moved from the International book/theme as it seems to better fit here.
- CWS:  Our Man has read the Crossing Wall Street blog for most of the last decade, and this ETF is based off that blog.  CWS publishes an annual “Buy List” of ~25 stocks at the start of each year, which are equally weighted and then no changes can be made during the year.  Each year only 5 stocks from the Buy List have been replaced, with the others carried forward (with any additions) onto the new Buy List.  This longer-term focus (typically, 4-5 years on the Buy List) leads to a bias towards quality and value and if the process can remain disciplined this can lead to out performance over time.


Commodities: 3.4% 
This book was changed from Precious Metals to better encapsulate the things that might go into it
- The Uranium stock ETF (URA) was added during January, and is the sole position in this book.  OM will likely go into the thesis on Uranium in greater detail at some point, but the cliff notes are:
1). Supply: 70% of supply comes from 2 producers (Cameco, a North American company, and the Republic of Kazakhstan) and both have cut supply in the last 12months and announced their intention to keep it down.  It takes a really long-time (5-7years+) to permit, build, and develop a mine so this capacity constraint has limited offsets.

2). Demand: The primary demand for Uranium is from nuclear power plants.  Post-Fukushima the demand fell substantially as Japan (and other countries like Germany) closed down their nuclear power plants.  Over the last year+ we’ve started to see some of these Japanese plants being updated and come back online, while other countries have approved and are building new (typically Generation III/III+) nuclear plants.  The building of new plants takes time (5-7 years to the plant approved, built) and will likely be slow (as countries wait to see how the new Generation III plants operate) but represents positive incremental change.  In the short-term, contracts for uranium supply are long-term (2-10yrs) with a significant percentage coming due within the next couple of years.

3). Price/Technical:  URA is down 80-90% from its 2011 peak and hit a low of $11.31 in mid-Jan 2016.  Subsequently, it held above this low in early November ($11.74) and confirmed a yearly uptrend in early 2017 (it’s price in 2017 closed at a level higher than any price in 2016!).  OM’s technical model suggests that the future path of URA is more likely to be a bear market rally than the start of a new bull market, but also that this could well be a particularly vicious bear market rally (to $40+!!!) given the depth & time of the decline.

Given this combination of supply/demand factors and the price/technical lining, OM believes that URA currently represents an attractive risk/reward.


Currencies: -47.6% 
OM continues to remain very long the US Dollar, with short positions in the Euro (via EUO) and Japanese Yen (via YCS).  The Euro short is around 2x the size of that in the Yen, with OM continuing to believe that the Euro will comfortably break par to the Dollar within the next 12-18mos.


China Thesis: 2.3% 
There are two components to OM’s China thesis; (i) that the Chinese are seeking to transition their economy to a Consumer-driven one (like the US/Europe/etc) and away from a Fixed Investment one, and that (ii) that they will provide as much monetary support as they’re able to in an attempt to smooth this transition.  To some degree, the Chinese internet positions (JD and VIPS) in the Equities book incorporate the view described in part (i) but in the China Thesis book it is expressed via a small short position in the Australian dollar (42% of Australian exports go to China, in particular commodities used for Fixed investments).  This short position has been substantially larger than it is today (10%+ vs ~1.5%). Part (ii) of the thesis is expressed through a position in Chinese A-shares (~3.5%) with OM believing that much of China’s monetary support will end up finding its way into the local stock market and that 2007 and 2015’s highs (50%+ above here) will be eclipsed before the market finally peaks. 



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. 

Portfolio Update - Summer 2015

It’s been a while since OM gave a portfolio update, but after much promising, here it finally is…

International/Country – 34.6% 
The International/Country book is made up of 2 main exposures; Europe and Argentina.
- Europe (~19%): About 3/4 of Our Man’s European exposure is split between Spain and Italy, with the balance in Greece.  This reflects the long-term cheapness of Spain and Italy (on a CAPE-basis) coupled with the stronger technicals and higher probability that these countries are through the worst of their problems.  Greece appears exceptionally cheap, though this may prove superficial given the scale of the economic depression that the country has been through since the Financial Crisis.

- Argentina (~12.5% spread across 5 names):
The catalyst for the Argentinean positions is the upcoming Presidential election in Q4, and the positive news is that both of the primary candidates appear to understand the need for change, to improve the economy and to settle with the bond holdouts (giving Argentina access to global bond markets).  The big questions surround the timing and the ability of the candidates to execute.
The worries about Scioli center on whether he is too close to the existing regime, something that his VP choice (an ally of the President) only fueled.  However, he has the broad support of the Peronists and thus is likely to be able to push changes through, though this will be in a more gradual manner as he builds consensus.  As such, there remains the risk of an economic issue/crisis before change is implemented and can have an effect.
Macri is the bolder ‘change’ choice, as he is likely to attempt to try to do things much more quickly.  The questions surrounding him are whether, after the initial honeymoon period, he’ll be able to push things through (given his status as an outsider) or will he be bogged down fighting the opposition.

- GVAL: Is a very long-term holding; given this OM wanted to wait a full cycle before making any decisions on it, thus if was sized very small.  So far the performance has been disappointing, though the performance was (and still is) expected to be characterized by periods of large under/over performance.

Technical book – 34.1% 
As mentioned when it was implemented, the Technical book has a longer-term bias and changes are not expected to be made to it on a regular basis.  Thus unsurprisingly this year has shown no changes, especially with the market being in a ‘dead zone’ between 2040 and 2135 for the the last few months.  It’s broadly OM’s expectation that this is a long consolidation that’s likely to break the upper limit and start a strong move lasting into 2016.  So far that hasn’t happened, but despite some internal weakness in the market (advances/declines, and ever decreasing breadth, coupled with the reaction to companies missing/making numbers), it would likely take a move comfortably sub-2000 for the Technical book’s sell signals to be triggered.  (Editor’s Note:  And this is why you don’t leave a semi-written blog post waiting to be finished for a month or two.  The market closed on Friday at 1971, right around the level where the Technical book’s initial sell signals are triggered)

Equity Book – 22.5%
At this point there are 4 names in the book:
- RDY and TTM are both Indian stocks though there is no great theme to these investments.  There has also been no great change to either story; the generics business continues to grow strongly (RDY) and Land Rover/Jaguar have started to roll out new models and the rationalization of the manufacturing underway (TTM).

- VIPS and JD are both Chinese Internet retail/consumer plays.  China’s development has come at an interesting time, coinciding with the technological jumps that come with the Internet, meaning that that the country’s retail model could be very different to those of the already developed world as it moves more directly/aggressively to the internet (and mobile) rather than brick-and-mortar stores.  This wouldn’t be the first time we’ve seen a developing country skipping a step as it modernizes; most obviously with India moving straight to mobile telephony rather than putting fixed telephone lines down across the country.
As with (seemingly) all Chinese companies, there is speculation as to whether these companies are ‘real’ and though OM has never been to China, he has sources who’ve met both companies, seen their sites, etc and is thus confident that both companies exist and have real businesses.   
VIPS is comfortably the larger of the two positions, owing to the fact that (despite being an ‘Internet’ company) it’s profitable & generates cash – while some are disappointed by its recent growth, OM sees not competing aggressively for bad business to increase revenues (at the expense of margins, profits, etc) as a sign of good long-term management.

- Currencies (21.9%) & China Thesis (11%) 
Our Man has stated a number of times on this blog that he’s a dollar bull.  It’s his highest conviction belief that we’re in a dollar bull market, a true secular bull market in the dollar, which is something we’ve not seen for decades.  While it’s not ignored OM doesn’t really think it’s fully realized that the Federal Reserve hasn’t raised rates in over a decade, and the US Dollar hasn’t been in a true secular bull market for almost 20 years.  While the dollar’s recent rally has been noted by the markets, it barely compares to historical secular bull markets such as the 90% rally in the 1980s and the 50% rise in the 1990s!  Furthermore, with a more globalized world now, the impact of the rising dollar is likely to be larger than people expect – instead of Poles with loans in Swiss Frances, it’s going to be global corporates that have borrowed in US Dollars (especially in those countries, *ahem* China, where a pegged currency has led to the rapidly crumbling illusion of no currency risk).  As for China, the slowdown has clearly impacted commodity prices (a number of which are at, or threatening, their 2008/2009 lows) and it’s spilled over into the currencies of the commodity countries.  The China book’s Short Australian Dollar position has been great and OM expects it to be volatile but very profitable for a while.

- Precious Metals – 9.3% 
While OM’s medium-term thesis here - that Precious Metals are going to have a strong bounce (the kind that would have the would-be gold bugs believing again) - may prove to be correct he took the position too early, much too early.  OM would have been better off waiting for that final leg down, rather than getting into the positions.

Portfolio Update – February & March 2014

February & March saw the some changes to the portfolio in some time, so it seemed sensible to use an entire post to explain what’s going on.

China Thesis 

As you all know, Our Man has been bearish on China for some time and this has been expressed intermittently in the portfolio, primarily through this sleeve of the book.  For the last 6-12mos, the chosen expression of this theme has been a Short Australian Dollar position, where the risk of potential stimulus in China has been partially offset through a Long Chinese A-Shares position.  It has broadly worked reasonably well, with the China Thesis book contributing >50bps+, over the last 6-12mos and both sides of the trade contributing to performance.  However, with the decline in the Australian Dollar from above parity (A$1>$1.04) in Q2-14 to well below parity (A$1 <$0.87) in early 2014, and the public discourse (read: breathless CNBC discussions) surrounding the fears of weaker China growth, Our Man decided to reposition this book.  This was done through substantially reducing his Short Australia Dollar position, with the hope of being able to rebuild it later in the year at a better price (i.e. just below parity), while retaining the Long Chinese A-Shares position (in case there is any government stimulus to help the economy).

Equity Book:  

Those who know Our Man, know that he’s fascinated by India as a potential investment arena for the next decade or two; it’s a country (and market) that comes with vast opportunity (demographics, size, consumer behavior, education/technologically advanced workforce, solid legal process, etc) as well as many challenges (governmental issues, slow legal process, a bifurcated market between large/small cos where foreign inflows can exert too much influence, etc).  Our Man was hoping to find a suitable ETF or Mutual Fund to express this view through but was unable to find anything of great interest, though the search did lead to a some interesting stock ideas (US-listed ADRs), which resulted in 2 new positions for the fund. 
- Dr Reddy's (RDY):  Dr. Reddy’s has achieved meaningful scale as a manufacturer of complex generic drugs, many of which have limited competition (it’s focus is largely on delivery forms other than solid dose/pills).  At year-end, the firm had a strong pipeline with 62 drugs pending FDA approval (39 are in the 180-day exclusivity bracket, and 9 were first to file products), and the US already generates 40% of sales (c$800mn) having grown almost 20% in 2013.  These all hint at some useful future traits (pricing power and growth) to supplement a strong existing business (60% gross margins and 20% EBITDA margins, on average over the last 6yrs) 
- Tata Motors (TTM):  Tata Motors is known as the manufacturer of the cheapest car in the world (the Nano) and one of the largest commercial vehicle manufacturers globally.  Most people don’t realize that it is also the holding company for 2 very well-known luxury banks; Jaguar and Land Rover (JLR), which represent the vast majority of revenue and all of the group’s profits.  With new models and refreshments of existing lines being key drivers of car sales, Our Man likes that JLR has a half-dozen+ coming out in the next couple of years, the reduced risk of cannibalization (Jaguar’s sales are 450K units/year) and the opportunity for JLR given the huge holes in JLR’s line-up (no convertible till the F-type came out, no station wagon/estate product in Europe despite it being 60% of the sedan market, no all-wheel drive Jaguar, despite all-wheel drive being 40% of North American sedan sales, etc).  These new launches, coupled with the ongoing rationalization of manufacturing (starting factories in China and Brazil) helps create interesting operating leverage.  With the business being profitable as is (Jaguar is too small so breaks even, but Land Rover is exceptionally profitable) and at an attractive price (10x this year’s earnings), Our Man has started a position. 

- Internet Names: The recent sell-off in markets has been centered on those stocks that (i) are primarily growth stories (i.e. a large part of today’s value comes from what investors expect to happen over the next 5-7years) and (ii) have performed very strongly over the last 6-12months.  Numerous reasons have been posited for their decline including the prospect may increase rates earlier than previously expected (meaning a $ of profit 5-7 years in the future, is worth less today than it was before), increased risk aversion (blamed on Russia-Ukraine), that the names were over-owned and suffered from profit-taking and the lack of natural new buyers.   While there are certainly elements of truth to all of these factors, and the valuations of this group of companies is still rich, there’s likely some opportunity to take advantage of the very negative sentiment and hold some of the names (at least for the next 6-12mos).  As such, Our Man started positions in PNQI (an ETF of a number of large well-known Internet names, think Amazon, Facebook, Ebay, etc), P (Pandora; online radio), and TWTR (Twitter; though OM doesn’t tweet) in the US.  OM also bought 2 US-listed, but more internationally focused named within the group, QIWI (QIWI; a provider of payment services in Russia and the CIS, which interests OM given the low trust in Banks in the region…think a complicated mix of Visa/Mastercard, MPesa, Moneygram, etc) and VIPS (Vipshop Holdings; a Chinese online discount retailer…think the online TJ Maxx of China).  In total these new positions represent c12.5% of the portfolio, with the PDXI being the largest component of this (and the others being roughly equal in size).

International Book 
Our Man has long been a fan of CAPE (Cyclically-Adjusted PE ratio) as a good signpost for whether a market is cheap and where one should look for ideas.  Thus, Our Man was very excited by the launch of the new Cambria Global Value ETF; Meb Faber and Cambria have done some of the better CAPE work on global markets and this ETF takes advantage of that…buying the cheapest ($200mn+ market cap) stocks, in the cheapest (CAPE) markets globally.  Given the small size of the ETF, the initial position has been restricted to 2.5% (+/- 0.75%, meaning Our Man would be a buyer if it fell to a c1.75% position and would take profits if it grew to c3.25%).

Absolute/Bond Funds 
With the possibility of higher rates (at the short-end at least) in the coming months, and the fund’s exposure to tighter credit spreads (and gold/gold miners in the case of HSTRX), Our Man decided to reduce his weighting to the 2 bond orientated funds in the book.

NCAV 
The NCAV screen was run, and found no names that met the eligible criteria.  Furthermore, with IMN having been in the NCAV portfolio for over a year since it last came upon the screens, it was sold (as per the NCAV book’s rules).  As a result, the NCAV book currently has no positions.

Technical Book 
The initial sell signals we saw in late January were invalidated by the subsequent rally in February and so, despite the market weakness of the last week or two, we wait for new initial sell signals.  While the Dow and S&P may show one (after a rise to new highs), the Nasdaq is the furthest away despite being the epicenter of the recent downturn in the market. 

Disclaimer:  For added clarity, as indicated in the post, Our Man is invested in almost all of the securities mentioned.  He also holds some cash and other securities too.  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.

Other Equities: Global CAPE Valuations (and Positions)

Our Man’s performance last year was disappointing, and one of the major sources of the disappointment stemmed from failing to capture some profits when positions moved significantly in OM’s favour before later reversing.  This was particularly the case with some long-term positions, such as EUO, which went was being a positive 50bps+ contributor to one that cost the portfolio over 30bps on the year.  Thus one of Our Man’s aims for 2013 is to show greater flexibility around his longer-term positions, especially by using technicals more to help with when to resize positions by taking profits or adding to positions.

Those who read this blog regularly know that Our Man likes discussing the CAPE, or the Cyclically-Adjusted PE (it’s can also be known as the ‘Shiller PE’), ratio quite a lot (such as way back when).   While the ratio is not very good at telling you what will happen with markets in the short or even medium term, it’s very helpful as a long-term guide to value or anchor.  Over the last couple of years, there has also been some great work and research done on CAPE’s globally and also using empirical data to test whether the ratio does indeed prove a good guide to long-term value.  The most interesting (and easily understood) stuff comes from Mebane Faber (Cambria Investments); and this recent paper provides a short and simple read that you don’t need to be an egg-head to understand.  Among the things that Faber’s work (and others) empirically shows is that when CAPE’s are low (i.e. the market is cheap) expected future returns are typically higher (especially over longer time periods, 5-10yrs.  See Figs 3A & 3B on page 5).  This also holds true outside of the US, where Faber looked at CAPE’s and returns for 32 markets (Fig 7 on page 10).

Why bring this up now?   Well, the crisis in Europe has seen markets fall and looking at the CAPEs, some are starting to reach valuations that are very attractive both absolutely and relative to the respective country’s history.  While getting good data outside the US is difficult (or expensive) for an individual investor, data back to the mid-90’s is very easily accessible and Our Man used it to create his own CAPE mini-database to get a sense of the valuations in Europe.  (NB.  You may notice that Spain is a glaring omission from the below.  Rather oddly, OM has misplaced his Spanish data…)

What should be reasonably clear is that valuations are clearly cheaper today than at any time in the last 7-10yrs in almost all of the countries.  While the US’ longer data set (see first graph in this post) suggests that the last 7-10yrs have not been particularly cheap in a historical context, it’s noticeably that in Italy (CAPE of just over 8) and especially Greece (CAPE of c2) valuations are at an attractive level on an absolute basis. 

Given these valuations and the longer-term nature of CAPEs, it makes sense that OM is going to try and apply some of the aforementioned flexibility by using technicals to help him get into and size positions driven by CAPE valuations.   Interestingly, both Greece and Italy appear to have formed potential bottoms during 2012.  While it’s not clear that the long-term pain in those economies and markets is over, it seems to make an interesting entry point. 

Given that CAPEs are a good guide to long-term valuation and Faber’s work which suggests the benefits are better felt through long-term holdings (i.e. 5yrs+), you should expect to see EWI and GREK in the portfolio for some time though their size will vary.  While the positions have been started in Italy (EWI) and Greece (GREK), given the sharper run-up in GREK since the summer, the position there is smaller (c1%) with Our Man looking to add to it if there’s a pull-back of note.

As a final note, neither EWI nor GREK hedge their currency exposure hence both would fall if the indices they track were flat (or rose), but the Euro weakened (more).  As such, at some point, Our Man may add some EUO as a short-term hedge specifically against these positions.