Portfolio Update

A very brief portfolio update, given month-end is upon us tomorrow.
As mentioned in the previous post, the Absolute Value bucket is now underway; all 3 positions were initiated today, at c50bips each, representing 1.5% of the portfolio.
Our Man also took the opportunity to sell out of the CRDN position, from the Other Equities bucket.

NCAV: Q1-10

While Our Man isn’t sure how long he’ll be able to run the Absolutely Value bucket, now is nonetheless a good time to at least start it.  The bucket is initially going to be based on Ben Graham’s NCAV work, and Our Man will be buying stocks which have a market cap below 65% of their Net Current Asset Value (= Net Current Assets – Total Liabilities).  Additionally, Our Man will limit himself to stocks with a market cap >$50mn, and will do a little qualitative work on each name he comes up (and thus may potentially remove some).

Without further ado, let’s take a look at the stocks that passed the test:

So, it seems our Absolute Value bucket will start with a mere 3 stocks…

What didn’t make the test?
Based on the mechanical CapitalIQ screen, eleven stocks made the list but 8 were rejected.  Why?
- 2 (NINE/XING) had stale financial statements (i.e. 6 months+ out of date) hence more questionable NCAV values
- 2 (NCTY/ULCM) no longer made the 65% criteria (i.e. they had marginally passed the screen, but the price rose between last week and today)
- 3 (CCRT/PCC/QCC) were Financial companies, where the screen appeared to use Total Assets rather than Current Assets due to the way they present their financial statements.
- 1 (NUHC) was rejected for qualitative reasons; the company just lost its largest customer (33% of revenues), for which it had a number of specially trained staff, and 40% of its current assets are represented by inventory (primarily for this customer).

Chartology: Some things Our Man's noticed...

Posting has been light recently, with Our Man has been distracted in the last few weeks by securing his permanent good-standing with US Immigration and dusting off his resume for the job-hunt.   However, with the back of that work broken, expect a livelier pace in the coming days/weeks.

As a little taster; here are some charts that Our Man’s keeping his beady eye on 

1) and 2) Some Economic Indicators

Two “Goldilocks” indicators (meaning that 0 = average trend growth) that give a reasonable sense where the economy is.  The first, the Chicago Fed National Activity Index, is based on 85 data series has been useful over its 10yrs in existence, with -0.70 normally being an indication that a recession is heading this way. 

The second, the Auroba-Diebold-Scotti Business Conditions index, is updated daily as new information comes in.  They’re both showing signs of rolling over but neither currently shows a double dip.

3) and 4) Copper

While the S&P has charged ahead since the start of the year Copper’s been left behind and failed to break December’s highs.  Our Man’s also still keeping his beady eye on the LME Warehouse Inventory levels.

5) Shanghai Composite Index
China was the first major market to carve out its bottom back in December 08, and start wandering higher.  It also was the first to peak in August 2009, and the peaks only seem to be getting lower…

Things Our Man's working on...

Unfortunately, the last few weeks has seen numerous distractions for Our Man (primarily, the small fund he was working out closing down and his US permanent residency interview) and as such he’s a somewhat behind in updating this blog. 

So without further ado, here’s a few of the ideas that Our Man is doing some work on.  Most won’t result in things that will head into the portfolio at this moment, but since Our Man thinks a number of the thematic-orientated ones are secular, there’s a reasonable chance that doing the work now will be somewhat helpful in the future.

Things Our Man is working on: Long Side
- Absolute Value (NCAV) Bucket
One of the strategies that has been consistently successful over time is buying stocks which have a market cap below their Net Current Asset Value (as developed by Benjamin Graham).  Our Man has a few screens, and will do a little qualitative work on each name he comes up with, but the idea is to build up a bucket of these names steadily over the next year.

- Value Idea Bucket
Our Man’s day-job was as an equity analyst, and as such he got to look at all sorts of companies on a bottom-up basis.  As such, expect a few names to potentially appear in this bucket as he goes about researching various ideas that wander across his radar.

- LED Theme
Our Man spent a lot of time studying, and recommending investments in, LED-related names at his old job.  LEDs are starting to become cost competitive in numerous areas (vs. other forms of lighting and backlighting) because they are more energy efficient (more light, less heat than the current forms of lighting).  The first wave of the LED implementation is seeing their use spreading rapidly in electronics devices (think your iPhone, Laptop, TV, etc), with the second wave being the holy grail in LED world (think the light bulb in your office/home, since the one you can see shining brightly outside in Times Square/Vegas is probably already an LED!).

- Lead Acid Battery Theme
Another thing Our Man spent his time working on was Batteries and Energy Storage.  While everyone and their dog, has proclaimed that Lithium-Ion Batteries are the future (all those shiny Plug-In Electric Vehicles), Our Man’s more impressed with their PR than their ability to power future Our Man's car!

- Water Theme
Blue Gold!  Oil was the most precious commodity of the 20th Century, Water will be of the 21st…

- Demographics
Are they destiny?  Our Man doesn’t know, but he does know that having lots of young people (think people entering the work force, starting to pay taxes and buy stuff!) is generally better for a country than having lots of old people (think Japan!).

- Brazil
Of all the BRIC’s, Brazil is the one that Our Man likes the most!  Why?  Demographics and Water (and other Natural Resources) are a good start!

Things to do: Short Side
- Copper/Australia: 
With China’s CPI rate coming in above their expectations, now’s the time to being to dust off the information on Our Man’s preferred instruments of choice, Copper and Australia.

- REITs (especially Hotel and Mall ones)
With cap rates tightening again, hotels having seen both Occupancy and PAR decline in 2009 (and PAR continue to decline in 2010) and Our Man’s concerns about the consumer, we may well be looking a little at the REITs.

Leading Indicators -- Japanese History and Current US

n the last post, Our Man mentioned that when equity and bond yields diverged in Japan stock market performance became more tied to economic cycle.  As such, going forwards, leading indicators should have greater value in helping us think about and control our equity exposure.  

Japanese Equity Performance and Leading Indicators

 

As the shaded areas hint, it seems reasonably conclusive that the leading indicators seem like a helpful tool and it would be wise to strongly consider reducing exposure when the leading indicators appear to be topping out.

Now, clearly, Our Man is not unaware of the pitfalls of using the leading indicators (such as “how does one define topping out in real-time”) or suggesting that they be the sole determinant of one’s exposure (because that would be moronic!) but is merely suggesting they’re another useful tool in terms of thinking about exposures.

Why bring this up now?  Well, let’s look at what’s happening to the US Leading indicators:

This certainly looks like some form topping out to Our Man, which would suggest that at the minimum that the easy money has been made in terms of a pure directional move.

Bond and Equity Yields -- 35yr Correlation Breaking down?

With all the debate about whether economic growth will be a V, a W, a square root, etc there have been a number of articles recently noting the market, unlike earnings, isn’t (or at least hasn’t) been particularly correlated with the economic cycle.   For anyone who’s ever looked at graphs of S&P and of S&P earnings, like the one below, that’s pretty undeniable.

However, that’s not the graph that Our Man wants to focus on today.  Instead, let’s look at a correlation that has lasted so long that it’s now almost an automatic assumption for investors; that between bond and equity yields.

 

As we can see by using both of the graphs, there have been 2 very clear patterns:

1965-1982: S&P going sideways, as profit growth is offset by multiple compression
1982-2000: S&P rising driven my multiple PE expansion
To put this 20-year multiple expansion into context, if the 03/00 peak had been at 1982’s 8.47x PE10, it would have been at a far less bubblicious S&P level of 545!  And it’d still be below that today…

As a further aside, Our Man is sure he isn’t the only one who has noticed the greater prominence of investors’ touting their “value investing” and other fundamental stock-picking tenets, over the last couple of years.  This should come as no surprise; the relatively steady Earnings Yield of c4% between mid-03 and mid-08 would imply a stock-pickers market where investor returns are driven far more by a an ability to understand a company’s fundamentals than by other factors.

However, though the Equity and Bond Yield relationship is largely ingrained in investor psyche, it is actually a new phenomenon and it hasn’t always been this way:

 

Evidence from Japan, where equities and bonds have noticeably decoupled since the 90’s, would suggest that things are perhaps returning towards their historical lack of correlation.  It also leads Our Man to ponder… that while we may have been able to create this relationship through our focus on rates as a monetary tool…will it still exist should using interest rates loses its primary role (due to a zero-interest rate policy) and effectiveness as monetary tool.

If so, Japan gives us a hint at what Our Man is looking for in equity world:
- Equity performance to tie more closely with the economic cycle
- Leading indicators (and especially their bottoming out and topping) to provide a broadly helpful sign of when and when not to take significant directional exposure
- Finally…a probable derating of equities. 
Why?  Predominantly as a greater risk premium should be introduced by investors to account for the more cyclical nature of equities but also due to investors’ long-term expectations proving overly ambitious (due to the deflationary/disinflationary environment limiting pricing power).