2014 has largely been a year of missed opportunities for
OM, some unfortunate (e.g. what eventually turned out to be a false sell signal
in the Technical book) but most self-inflicted; predominantly mistakes of
omission than mistakes of commission. This is broadly represented
in a consistent theme that you’ve seen since Our Man started running the book;
a significant level of underinvestment, too often caused by OM waiting for the
perfect price to enter (or add to) a name rather than starting to build a
position at a good price (i.e. with a sufficient margin of safety) and seek to
build it should it decline further. Thus, the big aim for 2015 and 2016,
is to get better at this…
Some things that are interesting OM for 2015, and
beyond…
- International Book - Argentina: This is one of
those positions that falls into the mistakes of omission, since OM has been
waiting to put on a position since Argentina defaulted on its debt over the
summer. On the surface there’s very little good to say about Argentina;
the country is in an acrimonious fight with some bond hold-outs from its last
default resulting in another default, the economy is terrible with high inflation, a weakening currency (which trades
at both official vs. unofficial prices) and high interest rates.
Given that, why Our Man’s interest? Well, everyone knows all of the above
and despite the huge rally in stocks, they’re still cheap by any
definition. However, this is with good reason; high and volatile interest rates, mean banks
only lend short term, which means businesses on focus on the short-term and
eschew investments where the future return may be substantial. Ditto for
investors, who rightly value short-term cashflow or earnings far more heavily
than any future earnings, due to the high discount rate. The opportunity lies in that during 2015, there are ‘events’ that could change this paradigm; (i) it becomes a lot
easier to negotiate with the bond holdouts as the calendar turns to 2015 (due
to the expiration of a clause in the restructured bonds), and more importantly
(ii) the current President cannot seek a third term,
with all 3 major candidates promising a break from the Kirchner's (Cristina
Kirchner has been President since 2007, and her husband was President for the 4
years prior) style and policies. Therein lies the upside potential – the hope of a sensibly governed Argentina (perhaps even with an independent Central Bank), with its limited fiscal deficit and debt,
and having ability to return to international capital markets would lead to a falling in
the risk premium and corporations focusing on maximizing return (including
future growth) rather than just surviving. The downside, is yet more of
what we’ve already seen, which is largely priced into the markets. Given
the lack of a good ETF, OM began investing in a small basket of positions in
Argentina to get exposure during December.
- Equity - Oil/Gas related: The decimation in the
Energy markets has been amazing to watch, with the Russell 2000 Energy losing around half its value in the last 6 months and many individual names suffering far more heavily than that! The sharp fall in oil has also reopened many of the debates
about fracking and how the US Shale boom has been funded.
From a historical analog, there are certain similarities to what
happened in 1985/86, when an influx of new production from the North Sea
increased supply and saw the Saudis choose to maintain market share in a period
of weakish demand, leading to a 60%+ decline in WTI within a 6month period
despite ongoing Middle Eastern tensions;
for 2014, substitute in US Shale (where production increased 1mn barrels per
day in 2013, and likely 1.7mn bpd in 2014) for North Sea. In short, Our
Man thinks there are going to be things to do to in Energy during 2015, but
we’ve yet to see the numerous corporate casualties (other than in their stock prices) that
indicate it will be a better time to look for those that might be
winners. As such, OM’s exposure will continue to remain of the
toe-dipping variety, but don’t be surprised if you start to see some Energy
names in the Equity book next year.
- Equity – Internet: OM loves the Internet and at this point, who
doesn’t? Be it shopping, catching up on the highlights from the big game,
keeping in touch with family and friends or just doing one’s work, the Internet is
pervasive*. OM doubts it’s even an argument whether the Internet is this
generation’s defining contribution and theme**, and like many of the prior
themes it’s not only reshaping our world but is a key force of the deflationary
pressure that we’re seeing globally. The Tech Bubble of the late 90’s was
clearly the very early innings, but it’s hard to say how far into the game we
are currently. While OM loves the Internet, he struggles to buy positions
in a world where valuation is based on Total Addressable Markets (TAMs, or how big a company’s market
“could” be) that can be almost anything and where low rates mean the value of future growth
is vastly more important than the value of any profitability in the near-term
(i.e. $100 at the end of 5years is worth ~$62 today at a 10% discount rate vs.
~$90-$91 today at a 2% discount rate). Thus OM has only really been a
buyer of Internet stocks at times when they’ve been sold aggressively (e.g.
early last year); expect this to continue into 2015. But like this year's Internet exposure, OM hopes that each
time he invests in these sell-offs there will be a name or two that becomes longer-term holdings for the
portfolio (like VIPS and TWTR in 2014).
* Furthermore people have now largely accepted the Faustian bargain
of the Internet; that it is “free” to use and “cheap” to buy things on, BUT in
exchange for all your personal data, whose protection & safety is currently not a priority for anybody be it individuals or corporations.
**OM will leave it historians to argue how it compares to
the Railroad, the industrialization of manufacturing driven by oil/gas, the
Automobile, etc.
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