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. 

Things from my Newsblur; 2018 Part IV

Time for another edition of “Things from my Newsblur”; as usual, the most investment-related stuff is at the end.

Eliud Kipchoge Is the Greatest Marathoner, Ever 
A well-timed interview/article by the New York Times, on Eliud Kipchoge.  Last weekend, the Kenyan obliterated the world marathon record in Berlin, and by posting a time of 2hrs 1min and 39 seconds he brought the spectre of running a sub-2 hour marathon into the realm of possibility.   For context, his new world record was 26+ miles at 4mins 38 seconds each…and if you’re looking to play along at home, turn your treadmill up to the fastest speed it goes and run for a couple of hours!   Unsurprisingly, a passion for running, singular focus, competitive desire and immense self-discipline feature heavily in Kipchoge’s story.  (Scott Cacciola, New York Time)   

Aston Martin building 28 Goldfinger DB4 reproductions - complete with gadgets 
For Bond fans of a certain vintage, the DB5 from Goldfinger is a classic!  Aston Martin are going to make 28 of them, and have teamed up with the special effects supervisor from the latest Bond film to design them.  If like Our Man, you don’t drive much, have no interest in spending a fortune on a car and much prefer to keep it simple…there’s already a LEGO version!  (Joel Stocksdale, Autoblog)  

The Untold Story of NotPetya, the Most Devastating Cyber Attack in History 
A fascinating account of the NetPetya virus; while targeted at Ukraine via an obscure locally popular accounting software, through a series of unanticipated events it ended up spreading globally.  It also revealed just how poorly everyone updates their computers, how fragile corporate IT systems are, and how interconnected we all are.   It’s worth reading this story, just to see how close AP Moeller Maersk came to losing almost their entire computer system, and the impacts this would have had across the globe.  These attacks aren’t going to get any less sophisticated, and like NotPetya it’s the unintended consequences (and victims) that will make or break them.  (Andy Greenberg, Wired)  

Brexit Explained 
Yes, OM is British. 
No, he doesn’t think a no-deal Brexit will result in people starving on the streets of London. 
Yes, Boris Johnson was probably right when he said President Trump would handle Brexit better than PM May. 
Yes, his rationale was pretty sensible and likely accurate. 
No, that doesn’t mean Boris would make a good (or competent?) Prime Minister
No, OM has no idea what’s going to happen.
However, if you want a good sense of the lay of the land, some well-thought out but easy to understand analysis, as well as likely probabilities then Helen Thomas’s article and blog are for you. 
If you’re so done with Brexit, I don’t blame you, and feel free to skip it
(Blondemoney)

What went wrong with IBM's Watson

IBM pitched its Watson supercomputer as a revolution in cancer care.  It's nowhere close. 
In the last portfolio write-up, OM talked about the fourth industrial revolution and artificial intelligence.  It is still early in that process, and IBM’s Watson seems a good example of where the marketing hype is somewhat advanced of the technological progress.  It’s by no means the only example, and there will be many more.  (Felix Salmon, Slate) and (Talia Bronshtein, STAT)  

The Next Financial Crisis Lurks Underground 
Bethany McLean, the journalist who led the reporting on the Enron scandal (and subsequently, co-wrote the excellent “The Smartest Guys in the Room”) writes about the paradox of shale companies, which are awesome and huge and "profitable" (imagine, OM doing finger quotes as you read that word).  However, as legendary short-seller Jim Chanos (see below for more on him) said for the article “The industry has a very bad history of money going into it and never coming out”.   This is not the first time the  dubious "economics" (more finger quotes) of Shale has been mentioned, even in the press!  However, like pretty much anything by Bethany McLean, it is recommended reading!  (Bethany McLean, New York Times)  

How Jim Chanos Uses Cynicism, Chutzpah - and a Secret Twitter Account - to Take on Markets (and Elon Musk)   
An interesting profile of Jim Chanos, “the Lebron James of short-selling”, who is best known for predicting the demise of Enron Corp back in 2001.  The article gives you a glimpse into the mind and approach of a short-seller, a group who tend to be rather non-conformist and ‘different’.  Chanos is the best known short-seller, having run short-focused hedge funds since 1985.  His funds’ performance is the perfect demonstration of both how hard short-selling is and also its value in a portfolio context; per the article, Chanos’ short-only fund has lost an annualized 0.7% per year, but his  flagship Fund that uses passive instruments on the long-side and offers market level exposure has returned approximately 2x the market’s return.  (Michelle Celarier, Institutional Investor)  

Why a Leading VC is Betting Big on a Decentralized Internet 
With the big fall in Bitcoin/Ethereum/etc this year, many have been quick to label the entire cryptocurrency and blockchain space as dead/a bubble/all over.  This is the counter-argument, that while prices got well ahead of the technology last year, the space continues to attract exceptionally smart folks; both on the VC-side and the engineer/technical folks who may make yet make it a success.  Chris Dixon, of Andreesson Horowitz, talks about what he sees in crypto and why he’s launched a fund focused on it.  (Kevin Maney, Breaker)