Portfolio Update: No Más!

Our Man followed through with the things on his docket last week, reducing the portfolio’s exposure about 8-10% above Thursday's market bottom.  Frankly, OM hopes it’s a decision that looks abysmal in the future, since that likely means that COVID-19 came and passed quickly with limited impact.

The primary rationale for it was a combination of material year-to-date losses, increasing evidence of the West’s questionable handling of the COVID-19 outbreak, and the increased uncertainty caused by COVID-19.  

• The losses began with Shipping’s sell-off in January and accelerated last week, as emerging market indices collapsed.
• It appears that most of the Western governments were caught off-guard by the spread of COVID-19, and reacting to events rather than having proactive plans.   Bizarrely, the UK is an exception; it has a very clear plan though it is highly controversial and has been at least partially misunderstood.   If you’re in the UK you must read Azeem Azhar’s newsletter post on it.  If you're not in the UK, you should read it anyway.
• The uncertainty around COVID-19’s impact is worth discussing as ideally one should be a buyer in weeks like last week when there is “blood in the streets”.  The argument for buying now is that this too shall pass, and numerous high quality stocks cheap on historical (or post-COVID-19) earnings.  Thus buying today is right, even if there’s another 10-20% downside, as these names will be markedly higher in 12-months’ time.  Normally, OM would nod in agreement.  However, with COVID-19’s spread to Europe and the Americas, the weak response and the potential multiple week lock-downs ahead OM believes the range of outcomes is exceptionally wide.  In the best case, it will look like nothing more than your typical economic or market slowdown and OM’s decision will be costly.  However, the impacts of a prolonged lock-down are non-linear; too many (both large and small) businesses have too thin margins, too many fixed costs, and too much debt to be able to survive with limited revenue for that long.  That starts to raise questions of the health of the economy we'll come back to post COVID-19.  OM suspects that in many scenarios, the solution is going to look a lot like MMT.

Portfolio Changes

The planned reductions to the portfolio were discussed in the previous post but were:

• Technical Book:  The Technical Book’s sell signal flashed in the final days of February, but OM waited for a meaningful bounce that never really came.  He exited it at the close (thankfully!) on Friday, but the delay (vs. the first trading day of March) cost a couple hundred bps!
• Greece:  OM cut this back materially.  It was the only particularly hard decision in the reduction of exposure.  The new government in Greece is largely doing very good job, including their fast response to COVID-19, but it doesn’t matter.  The economic rebound is going to be tested by COVID-19’s impact on tourism among other things, and Greek equities are going to get limited attention from investors.  The Greece ETF is trading below the levels when folks thought the country was run by a Crazy Leftist and about to leave the euro for the drachma.   This is why it’s still the 2nd largest position in the book.
• Brazil, India & Vietnam:  Both Brazil and India saw their first COVID-19 cases during the week, which led to OM to slightly increase his reduction in those positions.  Longer-term, Vietnam continues to a beneficiary of broadening supply chains but was also reduced.
• SaaS & Uranium:  The exposure to the older ETFs was cut back.  There are some more recently launched ETFs that better fit the theses, and OM will be adding these when the moment comes.  OM also trimmed back the JD.com position, which is up for the year.

OM also bought some more crude and oil product tankers!

In the week since OM’s last post on Shipping, Saudi Arabia and Russia started an all-out price water which saw oil prices tumble 30%+.  The combination of the attractiveness of storing crude & oil products and the Saudis hitting the bid on every VLCC tanker they could find saw tanker rates rise 4-8x last week!  This is the start of the low season, but instead rates are printing at all-time highs; there are ships that are literally making a year’s worth of income in a single 45-day voyage!!  OM added some Double Hull Tankers (DHT, crude tanker company with a fleet of VLCCs) but didn’t get filled in his attempt to buy Teekay Tankers (TNK).  If these rates continue and the stocks don't reflect it, expect OM to continue to keep buying more of his existing positions (and TNK) till he hits 25% NAV.    Given the cash flow that these companies are going to throw off in Q1 and Q2, OM is happy keeping this position at a much higher size though he’ll be selling lots of the rest of the portfolio to keep overall risk in check.  OM exited the existing position in Navigator Holdings (NVGS), which is focused on liquid natural gas not crude and oil products.

Portfolio (as at 03/13/20 - all delta and leverage adjusted, as appropriate)

Dislocations: 31.0%

17.9% - Shipping (STNG, DSSI, EURN, DHT and NVGS)

9.9% - Greece (GREK, ALBKY, and EGFEY)

3.2% - Uranium (CCJ and NXE)

Thematic: 15.1%

5.2% - Tech 4th Industrial Revolution (JD & WCLD)

3.4% - Vietnam (VNM)

3.3% - Brazil (EWZ)

3.2% - India (INDA)

0.0% - Blockchain/Crypto (no positions)

Technical: 0.0%

0.0% - OEW Technical positions (DDM, SSO, and QLD)

Idiosyncratic: 16.9%

14.2% - Funds (ARTTX, CWS, GVAL, and CAPE)

2.6% - Equities (TPL)

Shorts/Hedges: 0.0%

Cash: 37.1%

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it 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. 

COVID-19 and Portfolio Thoughts

Well, that was a fun! *sarcasm alert*

Our Man isn’t a doctor and, unlike far too many in finance and politics, he doesn’t even want to play one on TV! It says far too much about today’s world that the most sensible thing about COVID-19 from a non-expert came from the manager of Liverpool FC!

Thus OM isn’t going to opine on the spread of COVID-19, how you should deal with it, and what the various estimates of the virus’s potential R0, incubation period and case fatality rate are or what they might mean.  If, like OM, you work at a smaller company he will point you in the direction of Elad Gil’s primer and if you want to start thinking about the broader economic effects of a pandemic then Professor Wren-Lewis has you covered.   The three things OM will note is that so far we’ve learned:

1. Strict containment works in limiting COVID-19’s spread (see Singapore)
2. Aggressive and broad testing helps identify early who to isolate in order to prevent the virus' spread (see South Korea).
3. Western countries have, so far, been slow to do both of these things.

Instead OM is going to talk about is the market and some forward looking thoughts, as well as what it might mean for the portfolio. 

While COVID-19 originated in China, it was largely ignored by Western markets until the end of February, which coincided with (was caused by?) a sharp rise in cases in the West. The subsequent correction has been swift, sharp and brutal.   The largest factor in COVID-19’s market impact is the uncertainty – how far will it spread, how bad or deadly is it, and how much impact will it have on the economy and life. In the absence of high quality data, and limited trust in leadership and institutions (WHO, Chinese Government, CDC, etc.), the range of outcomes is wide and it’s often the loudest, not the best placed, voice that holds court. After not affecting the markets for ~6 weeks, this uncertainty quickly became doubt and fear.  In such times, investors go where they feel safest and to what has worked previously – especially government bonds. In the US equity markets, that has been Software and especially Software-as-a-Service, which ended February +7% for the year.

Since COVID-19 started in China, OM will be watching to see the resumption of normality there first.  Like all systems, China’s is incentives based - watch what the government does not what it says. OM is doing that by stealing Bill Bishop of Sinocism’s playbook for signs of China declaring victory.   OM doesn’t expect to be a buyer of much until we at least start to see:

• Xi visit Wuhan
• The Two Sessions is re-arranged
• Kids are sent back to school

OM’s operating assumption is that the uncertainty is the West will linger until there is greater clarity on COVID-19’s spread and impact, and the stock market will reflect this.  The longer it lingers then the worse the economic impacts of COVID-19 will be.  Even at this stage, OM suspects we’re starting to approach the point where we need both fiscal and monetary stimulus and the much like in 2008, it’s not going to come (in enough size) immediately.  Finally, the UK with an emboldened Prime Minister, a new Chancellor and a new Governor of the Bank of England might even be the first country to go full MMT on us!

So what is OM doing with the portfolio?

Unfortunately, nothing so far. 

Here are the things on his docket for the coming days/weeks:

- Technical Book: It saw its sell signal near the end of February.  Real-life issues meant OM failed to exit it during last week’s bounce, he won’t be so remiss next time.

- Uranium:  Though it has largely held up pretty well, OM is looking to exit the Uranium ETF (URA) position that is about 50% of the uranium exposure.  This reflects the reconstitution of the ETF to provider broader uranium exposure, and not just to the miners.  OM’s thesis is focused on the miners and a new more appropriate ETF (URNM) launched at the tail-end 2019.  Expect the capital to end up there eventually.

- Emerging Markets exposure:  OM has a LOT of it – Greece, Vietnam, Brazil and India are ~40% of the portfolio.  Irrespective of the long-term outlook, in times of financial stress emerging markets are never the place to be and OM will be trimming this exposure back.  This was not an unknown risk, and he should have been more proactive much earlier in the year!

- Software-as-a-Service: is largely flat on the year, despite everything.  OM suspects that it goes one of two ways from here: 

(i) COVID-19 fears are quickly dispelled and Software becomes that mythical investment; it protected when there was huge uncertainty and is also growing rapidly.  If so, OM expects to hear justifications that surely such a business, which was valued at 10x Sales before the model proved itself in times of economic stress deserves a higher multiple still?  And so, a real bubble shall have its narrative (and crypto as the logical extreme of this concept will go crazy).

(ii)  Or perhaps SAAS stocks are just 2020’s version of commodity stocks in 2008 – bullet proof and up healthily in mid-2008, until they collapsed to end the year down ~80%.  If so, they’re probably an attractive buy with far far better valuations at that point!  

Either way, OM will be exiting his position in the broad Software ETF (IGV); originally, it was the best of the bad proxies for SaaS.  OM would rather add capital to the existing position in the WisdomTree Cloud Computing ETF (WCLD), a recently launched SaaS-specific ETF, when it becomes clearer which path software will take.

- Shipping:  Oh shipping, that beautiful delightful hot mess.  See the most recent post!

Disclaimer:  Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it 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: Greece is the Word!!

With OM’s position in Greece having been sized up to 20% of the portfolio (start of Q2), it deserves a post of its own!    While OM  has provided updates on his Greek thesis before, which can be found here and here, the entirety of the thesis is not available in a single place.  This post, will rectify that. 

Our Man’s Greek exposure is primarily held through the Greece ETF (GREK) as well as smaller positions in two Greek Banks – Alpha Bank (ALBKY) and Eurobank Ergasias (EFGEY).

OM believes that the public markets reward contrarianism, especially when it’s tied to common sense, and his playbook for a dislocation is:

1. An investment that has had abysmal performance.  Ideally, investors will have been burned badly and/or are fatigued by the situation, which means it is likely overlooked.
2. Valuations are cheap and the fundamentals are turning, yet very few people care, and the stocks should at least suggest that they have found a bottom.
3. A change in narrative that provides an excuse or all-clear sign for investors to consider the area investable once more.

From OM’s research, the most attractive part of the investment is the ~24 months after the narrative has changed.  While the situation may continue to be attractive, potentially for many years, once it gets beyond a couple of years it will fall into OM’s Thematic portion of the portfolio and be evaluated and sized on that basis.

1) It All Goes Wrong for Greece

For Greece, the Global Financial Crisis was followed by a starring role in the European sovereign debt crisis.  While most people are largely aware of the Greek debt problems and the associated economic problems, the severity isn’t fully appreciated.  The crisis saw a 45% decline in GDP and unemployment top 27% in Greece – similar to what the US saw during Great Depression!

Greek GDP

Unsurprisingly, this saw Greek equity markets get decimated; down over 90% from their 2007 peak, over 80% from their post-08 highs, and over 70% from their 2014-highs.  The fall from 2014 is particularly important as ‘sophisticated’ investors helped recapitalize the Greek banks in 2013 and 2015, with the expectation that the crisis was largely over.  It was not!!

(click to enlarge)

Well for Greece, the opportunity is pretty clear; economic disaster and collapsing equity prices, over a prolonged period means that even ‘sophisticated’ money has been scared off.  

2). Valuations Become Attractive, and Things Turn Around

However, take another look at that chart of economic growth – things have turned around, and stabilized over the last couple of years.  Those aren’t the only signs though; the country passed over 450 reforms under the conditions of its IMF/European Central Bank/European Commission (the “Troika”) bailout deals and under those deals it is financed through 2033, when its debt amortizations start.  In exchange for this financing to help build a cash buffer, Greece had to agree to remain in a post-program surveillance program.  This helps guarantee the Greek government continues to deliver on its already enacted reforms.  Finally, for a country where people don’t pay their taxes and has historically spent recklessly, times are changing!  Greece has had one of the largest turnaround in public finances in history; it posted a budget surplus for the last couple of years and is committed to running one for years to come! 

Greek Government Budget Deficit

The same is true in equity markets, which bottomed back in 2016.  As a sense of the broad value in stocks, the CAPE ratio – an inflation adjusted 10-year price-earnings ratio – is negative!   With regards to the banks; Alpha Bank and Eurobank Ergasias ended 2018 trading at ~0.25x their estimated 2019 book value compared to European peers that traded at just under 1.0x.  Now, OM gets it…investors are rightly skeptical – after all there have been three bank recapitalizations this decade (2010, 2013 and 2015) that have seen investors lose almost all of their money.  However, OM would note that at this point regulators have been insiders on Greek banks for a decade (so book value really should be book value), vetted capital levels in continent-wide stress tests last year, and that Alpha and Eurobank both have 15%+ Tier 1 capital and are profitable!

Fundamentally, the banks continue to improve their non-performing exposures (NPEs) which have fallen 20% from the 2016 peak, with the ECB monitoring and acting as ‘big brother’ to help ensure this.  Last November, saw reasonable new NPE targets set by the ECB, working in conjunction with the Greek banks.  The ECB, the Bank and the Greek government all know that the banks must continue to reduce NPEs in order to be able to lend again, and help the economy grow.  This is why you’re seeing NPE sales by individual banks and various government plans being floated by the Central Bank  and Ministry of Finance to help speed up the process.  These combined with the recent Katseli law that makes it harder for people to strategically default, and the banks’ self-help (cost-cutting, etc.) are all  positive signs, and give the banks substantial operating leverage to improved conditions.

3) What will draw others back in

Which brings us to the change in narrative! Last year saw some steps in this direction, with Greece exiting its official bail-out program and raising money from the bond markets. Those bond markets, seem pretty sanguine on Greek risk.

The Greek government further took advantage of these low yields, to raise money and prepay $4bn+ of higher-interest IMF loans.  Further steps like this, and the banks continuing to fix themselves, will help but they won’t draw most investors back in.  That will require political change, and Greece is having elections in 2019! 

SYRIZA and their leader Alex Tsipras, who came to power in 2015, are broadly viewed as crazy leftists.   Yes, it’s in their name…SYRIZA being the syllabic abbreviation for The Coalition of the Radical Left.  Despite this, SYRIZA agreed to the Troika’s demands, passed bankruptcy laws, generated budget surpluses and helped the economy start to climb out of the abyss.  Irrespective, they are not a government that investors (especially US-ones) feel comfortable investing alongside.  However, 2019 is an election year in Greece and what if the country elected a leader that comes out of Western investors’ central casting?   You know, the kind that went to Stanford and Harvard, had spent time working for well-known US banks and consultancy firms before becoming a PE/VC investor, was pro-markets and business and came across as more efficient technocrat than ideologue.   Well, that’s the resume of Kyriakos Mitsotakis, the leader of the New Democracy party that’s currently comfortably ahead in the polls.   Should they seem likely to win as the election approaches, and eventually do so, I think it will remove a key obstacle for investors – Greece will no longer be scary, nobody will be fired for looking at it again, and it might even become the latest ‘unique idea’ for hedge funds.   This isn't to underplay all the good that Mr. Mitzotakis and a new government could do, just a reflection on what investors respond to.

Some Risks

While the above all suggest how Greece is setting up to be very attractive, under no circumstances should anyone think that it is even close to a risk-free investment.  As such, here are some of the key risks for OM.

• An important risk to the thesis is if global, and especially European, growth materially slowed down or became recessionary.  The most immediate impacts to the thesis would be to weaken the economic fundamentals in Greece and to increase the stress on the banks.  Additionally, stock markets and risk appetite would likely be weak in such a recessionary environment.  That wouldn’t spur anyone to invest in Greece.  In such a situation Our Man’s position should be vastly smaller.

• An obvious risk is that SYRIZA returns to power, hamstringing the change in narrative and remaining an impediment to investor interest rekindling.  A SYRIZA victory would also remove the optionality that a more business-friendly government could increase economic growth.  As such, Our Man’s position would be smaller, though it should be noted with the Troika continuing to monitor Greece’s compliance to its economic agreements, the fundamentals likely wouldn’t change substantially. 

• A final important risk is that the position, especially in the Banks, is dependent on regulatory forbearance.  The ECB has worked with the banks as a ‘big brother’ to set NPE reduction targets, and those most recently agreed for the period 2018 to 2021 were firm but fair.  Should the ECB change its approach it would likely mean further write downs and recapitalization for the banks that would negatively impact both investor and economic confidence.  While the ECB’s current plan is working well and the ECB is an independent central bank, the President is appointed by the leaders of the countries that have adopted the euro.  ECB President Draghi’s term ends in late 2019, and a new President (and team) may choose to take a different approach to Greek banks for their own political reasons.  This is something to continue to monitor, and much like investors the ECB decisions may be tied to the election result.

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 – Alpha Bank (ALBKY), Eurobank Egrasias (EFGEY) and the Greece ETF (GREK) - that’s a terrible reason for anyone else to do so.  Our Man also holds some cash and a many 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. 

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 (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. 

Greece 

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.

 Vietnam

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.

Overall

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.