2018: Second and Third Quarter Review

Portfolio Update  
- Idiosyncratic – TPL:  OM exited ~1/3 of the TPL position.  The reasoning was in (i) right-sizing the position given its 100%+ rise over the last year or so, and (ii) lingering questions on shale gas drilling.   These are neatly encapsulated in the Bethany McLean article from the last “Things from my Newsblur”.  While TPL doesn’t directly participate in shale drilling, it’s an indirect beneficiary.

- Technical Book:  Late in September, Our Man’s technical signals flashed its first sell signal in a couple of years and in keeping with the book’s rules, the positions were reduced.  The sharp deterioration in the technical signals caused OM to check them on a number of his other positions.  This led to OM cutting back the next two positions below, with a number of others being placed under much greater scrutiny.

- Thematic - The 4^th Industrial revolution:  OM exited the substantial majority of the Biotech position (IBB), driven by the strength of the technical signals screaming at him to exit soon.  The exit signs were much stronger than for the Technical book.  These together with some of the crazy valuations in biotech land (especially as discount rates rise) and the strength of the two major biotech indices - +50-100% since their 2016 lows, and over 5x since the 2009 lows – suggest substantial downside ahead.

- Thematic - India: After strong performance since Modhi won the election in 2014, the pace of change in India has slowed down with there being more questions (on reforms, on when the real benefits of Aadhaar will kick in, etc) than answers.  Smaller companies have underperformed for a prolonged period, and the technical analysis also suggested exiting them.  Thus, OM reduced his India exposure, by exiting the smaller companies’ portion of it (SCIF). 

 

Performance and Review 

The second quarter saw the portfolio fall -10.1%, which was substantially more than the S&P 500 Total Return (+3.4%) and the MSCI World (Net Dividends) (+1.7%).  A small recovery in the third quarter saw the portfolio rise +0.7%, though this lagged both the S&P 500 Total Return (+7.7%) and the MSCI World (ND) which rose 5.0%. 

Overall, YTD the portfolio’s performance is -9.7%, which trails both the S&P Total Return (+10.6%) and the MSCI World (ND) (+5.4%) by a material amount.

The portfolio’s poor performance was driven by the positions in Brazil (cost ~650bps, entirely in the second quarter) and Argentina (cost ~425bps, spread across both quarters).   Two primary drivers affected these positions (and some others);

• The first was the portfolio’s implicit short US dollar position caused by the foreign-country ETFs & ADRs (especially Brazil and Argentina).  As longer-term sufferers of this blog will remember, Our Man profited for a couple of years from a substantial long US-dollar position (against the Euro and Australian Dollar) before closing it out in 2017.  The end of this positive dollar thesis meant that OM was comfortable holding an implicit short position in the dollar.  However, during the second (and into the third) quarter, this implicit exposure proved painful as the dollar rallied on the back of expected Fed tightening.  Emerging markets, especially those with dollar debts such as Brazil and Argentina suffered most.  Almost half of the cumulative losses in the Brazilian and Argentinean positions are a direct result of their falling currencies.  As implied, OM was aware of and comfortable with the implicit short-dollar position.  Though the dollar moved more quickly that he expected, causing a larger impact, OM remained largely comfortable with the portfolio.  Hence, no changes were made.

• The second driver, sadly, was entirely OM’s fault.  Back in March, OM wrote “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”.  Two sentences later he followed it up by noting that the position was “unlikely to remain vastly outsized unless we see that push to impressive new highs”.  

- Did we see that push to impressive new highs?  

We did not, the Brazilian IBOVESPA index spent the next 2 months hanging out in the 80-86K range and never set new highs.

- Was there a substantial pullback?  

There sure was, the IBOVESPA fell away to trough at just under 70K and the main ETF that Our Man holds fell from $40-41 when OM wrote the above post to $31-32 at the end of the second quarter.

- Did OM avoid it by reducing his outsized position? 

Errr, so about that…OM could have followed his own advice and reduced the position early in Q2 without it hurting the portfolio.  He didn’t and thus bad portfolio management was a meaningful contributor to the poor performance in Q2.

- So he sold it in Q3, right?

He certainly did not.  OM’s big concern with the Brazil position was the election (going on now!); that was a bigger issue when EWZ was at $40-45 and everyone loved Brazil, than when it’s $30-35 and everyone’s petrified of Emerging Markets.

Having touched on these major contributors to performance, here is a brief round-up of everything else:

Dislocations

- Uranium (+55bps in Q2, and +39bps in Q3) was a positive contributor in both quarters with the price action of both the commodity (spot +30% in the third quarter) and the stocks finally improving.  There also continues to be positive news flow, with Kazakhstan planning on IPO-ing Kazatomprom and in the lead-up to it publicly committing to stick with a ‘valueover volume’ strategy. 

- Greece (-26bps, and -70bps) drifted back on currency, emerging markets and European (especially the new Italian government) concerns.  The most important factors remain that the economy remains stable/grows, that Greece comes back to the bond markets and especially the election (in 2019) that could provide a strong narrative.

Thematic 

- The 4^th Industrial revolution theme (-179bps in Q2, and -260bps in Q3) was a significant negative contributor.  The losses came from the two Chinese internet names, JD.com (JD) and Vipshop Holdings (VIPS).  Both suffered as Chinese stocks and the yuan retreated following the continued ramping up of tariffs by the US Administration.  JD also suffered after the CEO was accused of sexual assault in the US. 

- Vietnam (-62bps in Q2, and +16bps in Q3) and India (-42bps in Q2, and -35 bps in Q3) both posted small losses.  However, the two themes are heading in different directions, at least in the short-term.  As noted above, India’s markets technically appear to be in a relatively material correction. Vietnam, while not immune from the global pressures, continues to see incremental improvements fundamentally with 2018 on course for record FDI and the currency largely holding up. 

The Technical (+96bps in Q2, +260bps in Q3) books was a healthy contributors in both quarters.  The Technical book benefited from the rising markets, though as noted in the portfolio update section, OM’s approach flashed a warning signal in late September that saw the position size meaningfully reduced.

The Idiosyncratic book (+164bps in Q2, +153bps in Q3) also contributed in both quarters.  Texas Pacific Land Trust (TPL) continued its exceptional performance, rising 70%+ during the two quarters, as it continues to develop its water business and activity remains strong in the Permian.   The Funds -6bps in Q2, +61bps in Q3) benefited from the rising markets.


Portfolio (as at 09/30/18 - all delta and leverage adjusted, as appropriate)

Dislocations: 35.0% 

20.3% - Brazil (EWZ, and EWZS) 

9.8% - Uranium (URA, and NXE)

4.8% - Greece (GREK, and ALBKY)

Technical: 23.3% 

23.3% - Technical (DDM, QLD and SSO)

Thematic: 18.7% 

6.8% - Argentina (PAM, DESP, and AGRO) 

6.2% - Tech: 4^th Industrial Revolution (JD, VIPS and IBB)

3.2% - Vietnam (VNM) 
2.5% - India (IFN)

Idiosyncratic: 17.8% 
11.8% - Funds (CWS, GVAL, and CAPE) 
6.0% - Equities (TPL and FNMA)

Shorts/Hedges: 0.0%

Cash: 16.8%

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.